Chapter 7 - Valuing Stocks
After studying this chapter, you should be able to:
7.1 Understand the stock trading reports on the Internet or in the financial pages of the
newspaper.
7.2 Calculate the present value of a stock given forecasts of future dividends and show how
growth opportunities are reflected in stock prices and price-earnings ratios.
7.3 Apply valuation models to an entire business.
7.4 Understand what professionals mean when they say that there are no free lunches on
Wall Street.
7.1 Stocks and the Stock Market
Common stock, ownership shares in a publicly held corporation. Those investors who
bought shares in the initial public offering (= first offering of stock to the general public), or
IPO became part-owners of the business, and as shareholders they shared in the company’s
future successes and setbacks.
Primary offering, the corporation issues shares in the irm to the public in an IPO or SEO.
These are said to be made in the primary market (= market for the sale of new securities by
corporations). Secondary market, market in which previously issued securities are traded
among investors.
Reading Stock Market Listings → nog naar kijken
P/E ratio, ratio of the stock price to earnings per share. The P/E ratio is a key tool of stock
market analysts.
7.2 Market Values, Book Values, and Liquidation Values
Book value, net worth of the firm according to the balance sheet.
Liquidation value, net proceeds that could be realized by selling the firm’s assets and
paying off its creditors. A successful company ought to be worth more than liquidation value.
The difference between a company’s actual value and its book or liquidation value is often
attributed to going-concern value, which refers to three factors:
1. Extra earning power → A company may have the ability to earn more than
an adequate rate of return on assets. In this case the value of those assets
will be higher than their book value or secondhand value.
2. Intangible assets → There are many assets that accountants don’t put on
the balance sheet. Expertise, experience, and knowledge are crucial
assets, and their values do show up in stock prices.
3. Value of future investments → If investors believe a company will have the
opportunity to make very profitable investments in the future, they will
pay more for the company’s stock today.
⇒ Market price is not the same as book value or liquidation value. Market value,
unlike book value and liquidation value, treats the firm as a going concern.
, It is not surprising that stocks virtually never sell at book or liquidation values. Investors buy
shares on the basis of present and future earning power. Two key features determine the
profits the firm will be able to produce:
1. the earnings that can be generated by the firm’s tangible and intangible assets, and
2. the opportunities the firm has to invest in lucrative projects that will increase future
earnings.
To summarize:
1. Book value records what a company has paid for its assets, less a deduction for
depreciation. It does not capture the true value of a business.
2. Liquidation value is what the company could net by selling its assets and repaying
its debts. It does not capture the value of a successful going concern.
3. Market value is the amount that investors are willing to pay for the shares of the firm.
This depends on the earning power of today’s assets and the expected profitability of
future investments.
What determines market value?
7.3 Valuing Common Stocks
Valuation by Comparables
Valuation of comparables: when financial analysts need to value a business, they often start
by identifying a sample of similar firms. They then examine how much investors in these
companies are prepared to pay for each dollar of assets or earnings.
After studying this chapter, you should be able to:
7.1 Understand the stock trading reports on the Internet or in the financial pages of the
newspaper.
7.2 Calculate the present value of a stock given forecasts of future dividends and show how
growth opportunities are reflected in stock prices and price-earnings ratios.
7.3 Apply valuation models to an entire business.
7.4 Understand what professionals mean when they say that there are no free lunches on
Wall Street.
7.1 Stocks and the Stock Market
Common stock, ownership shares in a publicly held corporation. Those investors who
bought shares in the initial public offering (= first offering of stock to the general public), or
IPO became part-owners of the business, and as shareholders they shared in the company’s
future successes and setbacks.
Primary offering, the corporation issues shares in the irm to the public in an IPO or SEO.
These are said to be made in the primary market (= market for the sale of new securities by
corporations). Secondary market, market in which previously issued securities are traded
among investors.
Reading Stock Market Listings → nog naar kijken
P/E ratio, ratio of the stock price to earnings per share. The P/E ratio is a key tool of stock
market analysts.
7.2 Market Values, Book Values, and Liquidation Values
Book value, net worth of the firm according to the balance sheet.
Liquidation value, net proceeds that could be realized by selling the firm’s assets and
paying off its creditors. A successful company ought to be worth more than liquidation value.
The difference between a company’s actual value and its book or liquidation value is often
attributed to going-concern value, which refers to three factors:
1. Extra earning power → A company may have the ability to earn more than
an adequate rate of return on assets. In this case the value of those assets
will be higher than their book value or secondhand value.
2. Intangible assets → There are many assets that accountants don’t put on
the balance sheet. Expertise, experience, and knowledge are crucial
assets, and their values do show up in stock prices.
3. Value of future investments → If investors believe a company will have the
opportunity to make very profitable investments in the future, they will
pay more for the company’s stock today.
⇒ Market price is not the same as book value or liquidation value. Market value,
unlike book value and liquidation value, treats the firm as a going concern.
, It is not surprising that stocks virtually never sell at book or liquidation values. Investors buy
shares on the basis of present and future earning power. Two key features determine the
profits the firm will be able to produce:
1. the earnings that can be generated by the firm’s tangible and intangible assets, and
2. the opportunities the firm has to invest in lucrative projects that will increase future
earnings.
To summarize:
1. Book value records what a company has paid for its assets, less a deduction for
depreciation. It does not capture the true value of a business.
2. Liquidation value is what the company could net by selling its assets and repaying
its debts. It does not capture the value of a successful going concern.
3. Market value is the amount that investors are willing to pay for the shares of the firm.
This depends on the earning power of today’s assets and the expected profitability of
future investments.
What determines market value?
7.3 Valuing Common Stocks
Valuation by Comparables
Valuation of comparables: when financial analysts need to value a business, they often start
by identifying a sample of similar firms. They then examine how much investors in these
companies are prepared to pay for each dollar of assets or earnings.
