Stock Valuation Assignment

Stock Valuation Assignment Words: 1264

1. Introduction 2. 1 Background of the Studies Valuation is the first step toward intelligent investing. When an investor attempts to determine the worth of her shares based on the fundamentals, it helps her make informed decisions about what stocks to buy or sell. Without fundamental value, one is set adrift in a sea of random short-term price movements and gut feelings. Before we can value a share of stock, we have to have some notion of what a share of stock is. A share of stock is not some magical creation that ebbs and flows like the tide; rather, it is the concrete representation of partial ownership of a publicly traded company.

If XYZ Corporation has 1 million shares of stock outstanding and we hold a single, solitary share, that means we own a millionth of the company. There are some stock valuation methods that we can use in valuing company’s stock. For instance: Discounted Cash Flow Model (DCFM), Dividend Discount Model (DDM) and Earnings Growth Model (EGM). DDM is the valuation method that we use in this paper. 2. 2 Problem Statement and Objective This research is mainly to value Public Bank Bhd stock through Dividend Discount Model (DDM). 2. 3 Research Question What is the value of Public Bank Bhd stock? * Is Public Bank Bhd stock a worth enough stock for investor to invest in? 2. 4 Significance of the Studies The significance of the studies is to value Public Bank Bhd stock. The result that we generate in the end of the research can help the investors in making their decisions either to invest in Public Bank Bhd or not. 2. 5 Limitation of the Studies The Dividend Discount Model is a simple and convenient way of valuing stocks but it is extremely sensitive to the inputs for the growth rate.

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Used incorrectly, it can yield misleading or even absurd results, since, as the growth rate converges on the discount rate, the value goes to infinity. 2. Literature Review Stock valuation is the process of calculating the fair market value of a stock by using a predetermined formulas that factors in various economic indicators. Stock valuation can be calculated using a number of different methods. The most common methods used are the discounted cash flow method, the P/E method, and the Dividend Discount Model . In this study we are using Dividend Discount Model (DDM) to value company stock.

The DDM is a procedure on valuing the price of a stock by using predicted dividends and discounting them back to present value. The idea is that if the value obtained from the DDM is higher than what the shares are currently trading at, then the stock is undervalued. Lawrence J. Gitman and Michael D. Joehnk (2008) indicated that stock valuation is to determine what the stock ought to be worth, given estimated returns to stockholders (future dividends and price behaviour) and the amount of potential risk exposure. Whereas Motley Fool Staff (1995) said that stock valuation is the first step toward intelligent stock investing.

While Anastasia Vardavaki and John Mylonakis (2007) state that stock valuation is the process of forecasting the present value of the expected payoffs to shareholders and of converting this forecast into one number that corresponds to the fundamental-intrinsic firm value. Lee (1999) argues that valuation models are merely ‘pro forma accounting systems’ that constitute the vehicles for articulating the assessment of future events typically in terms of accounting constructs. According to Barker (2001), a good understanding of valuation methods requires two main things.

The first is an analytical review of the models, identifying their relationship and exposing their assumptions. The second is an evaluation of the data that are available for use of these models. Whereas Ping-Chen Lin and Jiah-Shing Chen (2007) indicate that stock valuation is very important for fundamental investors in order to select undervalued stocks so as to earn excess profits. Susan Chaplinsky and Robert S. Harris (2006) indicate that the Dividend Discount Model is based on the premise that the future cash flow the investor receives from the stock is cash dividends.

Journal by Stephen R Foerster and Stephen Sapp (2005) found that Dividend Discount Model perform well at explaining actual prices. Anonymous, 2009 stated that Dividend discount models are essentially tools that have been developed to value a stock on the basis of estimated future dividends, discounted to reflect their value in today’s terms. According to Punit Anand and Alex Faseruk (2008) define that the DDM is the model that calculate the investment value of stock as the present worth of all the dividends to be paid upon it.

Scott Pirie and Malcolm Smith (2008) stated that DDM is the most direct approach to valuing shares defines the benefits to the owners as the dividends paid during the holding period plus the proceeds received from selling the shares at the end of that period. Andrew Baum and Neil Turner (2004) define the DDM as a method that calculates the value of an equity security as the present value of future dividends. Thomas H. Payne and J. Howard Finch (1999) said that DDM is very sensitive to the relationship between the required return on investment (Ks) and the assumed growth rate (g) in earnings and dividends. 3. Methodology 3. 1 Type of Study

Descriptive Approach: Data is based on the past and current performance of the economy, industry and individual companies, to understand the causes for prevailing results and based on this future performance and opportunities are interpreted. 3. 2 Sampling Design Company is selected based on convenient sampling which is a listed company in Bursa Malaysia. The sample is: * Public Bank Bhd 3. 3 Data Collection The data collected and used in the study is purely based on secondary data that we obtain from Public Bank Bhd website. 3. 4 Data Analysis and Result We are using Dividend Discount Model to value Public Bank Bhd stock.

We are using this formula: Value of stock = DPS (1) / Ks-g There are several inputs that required computing the value of stock. * DPS (1) = Dividends expected to be received in one year. * Ks = The required rate of return for the investment. The required rate of return can be estimated using the following formula: Risk-free rate + (Market risk premium) * Beta * g = Growth rate in dividends. The growth rate in dividend can be compute using the following formula: ROE * [1-(DPS/EPS)] Below are the steps that we do to value Public Bank Bhd stock: DPS = Public Bank Bhd had a dividend of RM0. 55 per share at the year of 2009.

EPS = Public Bank Bhd had a earnings of RM0. 7332 per share at the year of 2009 ROE = Public Bank Bhd had Return on Equity of 24. 5% at the year of 2009 Ks = 3. 85% + (6. 3%) * 1. 0 = 10. 15% (we use a Beta of 1 because it should be the same as the market during the stable growth period) g = 24. 5% *[1-(RM0. 55/RM0. 7332)] = 0. 0612 @ 6. 12 %( we use growth rate of the year 2009 because we assume that the growth rate is constant for the next year) DPS (1) = RM0. 55 (1+6. 12%) = RM0. 5837 V = DPS (1)/ (Ks-g) =RM0. 5837 / (10. 15% – 6. 12%) V = RM14. 82 Public Bank Bhd’s recent price of RM11. 4 per share shows that the Dividend Discount Model suggests that the stock of Public Bank Bhd is undervalued. Public Bank Bhd stock is worth enough for investor to invest in. Investors are suggested to invest in Public Bank Bhd since the result shows that Public Bank Bhd stock is undervalued and there is huge possibility that the price will increase in the future. Appendices Appendix 1 Public Bank Bhd Summary of Key Financial Information for the financial period ended 31/12/2009 | Current Year to Date| | 31/12/2009| | RM’000| Revenue| 9,715,568| Earnings per share (sen)| 73. 32| Dividend per share (sen)| 55. 0| Return on equity (%)| 24. 5|

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