Chapter 8 - Stock Valuation

Dividend

The portion of corporate profits paid to shareholders.

Capital gains

The profit from selling a stock at a higher price than it was purchased.

Common stock

Equity ownership with voting rights and residual claim on income/assets.

Preferred stock

Equity with fixed dividends and priority over common stock but usually no voting rights.

Dividend Discount Model (DDM)

A valuation method based on the present value of future dividends.

Zero-growth DDM

A DDM assuming constant dividends forever; values stock as a perpetuity.

Constant-growth DDM (Gordon Growth Model)

A DDM assuming dividends grow at a constant rate forever; P₀ = D₁ / (R - g).

Supernormal growth

Dividend growth is high for a few years before stabilizing at a constant rate.

Required return (R)

The return investors demand for holding a stock, based on risk.

Dividend yield

The portion of return from dividends, calculated as D₁ / P₀.

Capital gains yield

The portion of return from price appreciation, equal to the dividend growth rate (g).

Total return

The sum of dividend yield and capital gains yield.

D₀

The most recent dividend paid.

D₁

The expected dividend next year; D₁ = D₀ × (1 + g).

P₀

Current price of the stock.

Benchmark P/E ratio

A standard price-to-earnings ratio used to value a stock based on expected EPS.

EPS (Earnings Per Share)

Net income divided by the number of outstanding shares.

Forward P/E

P/E ratio based on projected future earnings.

Trailing P/E

P/E ratio based on past earnings.

Price-to-sales (P/S) ratio

Used to value firms with no profits; compares stock price to revenue.

Preemptive right

The right of existing shareholders to maintain their ownership percentage when new shares are issued.

Voting rights

Right of shareholders to vote on corporate matters such as board elections.

Cumulative voting

A system allowing minority shareholders to concentrate votes on one candidate.

Straight voting

One vote per share per board seat; favors majority shareholders.

Proxy voting

Allowing someone else to vote on your behalf at a shareholder meeting.

Cumulative preferred stock

Preferred shares where unpaid dividends accumulate and must be paid before common dividends.

Noncumulative preferred stock

Preferred shares where missed dividends are not carried forward.

Dividend tax credit

A tax benefit for Canadian individuals receiving dividend income.

Stock valuation

The process of determining a stock's intrinsic value based on expected future cash flows.

Terminal value

The present value of all future dividends beyond a forecast period.

Stock price sensitivity

How the current stock price reacts to changes in dividend growth or required return.