Valuation of Financial Assets: Shares - Study Notes

A comprehensive set of flashcards summarizing key concepts related to the valuation of financial assets, specifically shares.

Present Value (PV)

The current worth of expected future cash flows discounted at an appropriate rate.

Ordinary Shares

Shares that provide ownership rights, voting rights, and eligibility for dividends, but dividends are not guaranteed.

Preference Shares

Shares that provide fixed dividends, priority in liquidation, and carry no voting rights.

Dividend Discount Model (DDM)

A model used to estimate the value of a share by calculating the present value of future cash flows.

Required Return (rE)

The equity cost of capital, which is not directly observable and is needed to discount future cash flows.

One-Year Holding Example

A case where a dividend of $1.75 and a final price of $50 after one year are analyzed with a required return of 15%.

Constant Growth Model

A valuation method where the price of the stock is determined based on growing dividends at a constant rate.

Retention Rate

The proportion of earnings retained by the company instead of being paid out as dividends.

Intrinsic Valuation

The estimated true value of a share based on fundamental analysis and not just on market price.

Market Price vs. Intrinsic Value

Investors compare these to decide whether to buy or sell shares based on perceived value.

Dividends in Perpetuity

A model projecting dividends that grow at a constant rate indefinitely.

Profitability in the DDM

The ability of a company to pay dividends is driven by its profitability.

Discount Rate (rE) in DDM

The rate used to discount expected future cash flows, capturing risk in share valuation.

Dividend Payout Rate

The proportion of earnings distributed as dividends rather than being retained for growth.

Changing Growth Rates

Valuation approach considering different growth rates during different phases of a company's growth.

Growth (g) in DDM

The rate at which dividends are expected to grow, calculated using retention rates and return on investment.

Value Drivers in DDM

Factors that affect the valuation of shares such as profitability and risk.

Limitations of DDM

Challenges such as unpredictability of future dividends and issues with non-dividend-paying firms.

Calculating PV of Expected Dividends

The process involves estimating dividends, determining required return, and discounting future cash flows.

Harris Mushroom Farms Example

An example used to illustrate dividend growth and valuation under changing growth conditions.