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5.i practice

Methods of Equity Valuation

  1. Intrinsic Valuation Approach
    • Discounted cash flow method:
      • Dividend capitalization model
      • Earnings capitalization model
  2. Relative Valuation Approach
    • Multiplier method

Dividend Capitalization Model

  • Basic Model: The value of an equity share is the present value of its future stream of dividends.
  • One Period Valuation Formula:
    \(P_0 = \frac{D_1}{1 + k_e} + \frac{P_1}{1 + k_e}\)

Where:

  • \(P_0\) = Value of share today
  • \(D_1\) = Expected dividend at the end of 1st year
  • \(P_1\) = Expected price of the share at the end of 1st year
  • \(k_e\) = Required rate of return

Multi Period Valuation

  • For holding the stock for n years:

\(P_0 = \sum_{t=1}^n \frac{D_t}{(1+k_e)^t} + \frac{P_n}{(1+k_e)^n}\)

Perpetual Dividend Valuation Models

  • No Growth or Zero Growth Model: \(P_0 = \frac{D}{k_e}\)

  • Constant Growth Model: \(P_0 = \frac{D_1}{k_e - g}\) Where:

  • \(D_1\) = Dividend after 1 year

  • \(g\) = Expected growth in dividend (%)
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