An Introduction to Security Valuation

Overview of Security Valuation Techiques

1. Valuation based on the present value of expected futrure cash flows.
2. Relative valuation techniques based on an expected multiple of a firm's expected performance, such as earnings per share or sales per share.

Top-down, 3-step approach

Economic Analysis -- Industry Analysis -- Stock analysis

Step 1: Forecast macroeconomic influence
Step 2: Determine industry effects
Step 3: Perform firm analysis

Forms of Investment returns
Cash flows from projects
interest income on bonds
dividend income on stocks
capital gains
increase in the prices of an asset

The General Dividend Discount Model (DDM): Preferred stock value = Dp / kp
Multiple-year holding period DDM: 不同年度的利息现值+末年本金的现值=证券价值
Infinite period DDM: PV0 = D1 / (ke - gc)

Assumptions of the infinite period DDM:

1. the stock pays dividends, and they grow at a constant rate.
2. the constant growth rate, g, is never expected to change.
3. k must be greater than g. If not, the math will not work.

推出公式 Pn = D(n+1) / (k - g)

Supernormal growth
由超级增长率求出n期利息dividend，然后折现n-1期的利息，用第n期利息根据DDM法则求出第n-1期本金，然后和折现的利息相+的出超级增长债券价值

P0 / E1 = (D1 / E1) / (k - g)

D/E = the expected dividend payout ratio
k = the required rate of return on the stock
g = the expected constant growth rate of dividends

There are several problems with using P/E analysis:

Earnings are historical cost accounting numbers and may be of differing quality.
Business cycles may affect P/E ratios.
k
RFR(nominal) = [1 + RFR (real)](1+IP) - 1
RFR(nominal) = RFR(real) +IP

k = RFR(nominal) + RP
k = RFR + b[E(R) - RFR]

Country Risk Premium:
Business Risk
Financial Risk
Liquidity Risk
Exchange Rate Risk
Country Risk

g=(Retention Rate)(ROE)
Retention rate = 1 - payout ratio

Net profit/ - ROE/ - g/ - (k - g)/ - price of stock/