Stock Valuation

Stock Valuation
Prof. Ameet Kumar Banerjee

Stock Market
• Platform for long term borrowing.

• Transparency in trading.
• Reduces information asymmetry.
• Offers protection to investors through oversight by SEBI.
• Leading Economic Barometer.
Regulator
• Securities and Exchange Board of India (SEBI) came into force on 12 th April 1988.
• Establishment of the SEBI Act on 30th January 1992, which gave SEBI to draft legislation,
implement and address redressal.
Powers of SEBI
• Has control of the bylaws of every stock exchange in the country and any amendment in bylaws
needs SEBI approval.
• The SEBI can also inspect the books of accounts of any stock exchange to check for irregularities.
• SEBI can also inspect books of accounts for financial intermediaries.
• SEBI can ask any company to list their shares on more than one stock exchange if they feel it
would be more beneficial to the market.
• SEBI protect investors interest through oversight of the market.
Investment in stocks
• Ownership & Claims of assets of the company.

• Earnings
• Capital gains
• Dividends.
• Voting rights
Trading Process & Flow process
IPO (Initial Public Offering)
• Company’s first venture to raise public money.

• Meant majorly for business expansion.
• Create a foothold for raising newer capital in the future.
• Fund acquisitions.
What goes against IPO
• Expensive - A typical firm may spend about 15-25% of the money raised on direct expenses.
• Reporting responsibilities - Continuously file reports with the SEBI and the stock exchange and
other stakeholders.
• Loss of control – Dilution of promoters' ownership.
When it is good to bring IPO
• The general stock market condition is normal or good.

• The industry market condition are motivating.
• The frequency and size of all IPO’s hitting the market in the financial cycle.
• Investors eagerness to enter capital markets.
IPO – Volume -Capital Raised through IPO
Upcoming and recently launched IPO’s
IPO process
• Select a Lead Bank (& Underwriter).
• Register IPO with the SEBI
• Print Red Herring document
• Present roadshow
• Price the IPO
• Float a fixed price IPO or Book Building Issue, the price or price band is fixed
• Sell the securities to the public (offer document is available both offline and online)
• Going through the IPO
• Stakeholders and under-writers work together to decide how many shares will every investor
receive.
• Investors will usually get full securities unless it is oversubscribed.
Lead Bank/Underwriter
• The lead bank oversees the arrangement of a loan syndication or securities underwriting,
recruiting syndicate members.
• An underwriter/lead bank is an investment firm that acts as an intermediary between a company
selling securities and the investing public.
• The underwriter is the principal player in the IPO.
• Typically, the underwriter buys the securities for less than the offering price and accepts the risk of
not being able to sell them.
Top Lead Banks
Types of Underwriter
• Firm commitment underwriting:

• The underwriter buys the entire issue, assuming full financial responsibility for any unsold
shares
• Most prevalent type of underwriting in the U. S.
• Best efforts underwriting:
• The underwriter sells as much of the issue as possible, but can return any unsold shares to the
issuer without financial responsibility
Examples of Underwriters in India
• ICICI bank.
• LIC.
• Axis Bank.
• Note: Underwriter, needs of certificate of registration from SEBI to act as underwriter
Computing the Price of Common Stock: The One-Period Valuation
Model
• Simplest model, just taking using the expected dividend and price over the next year.
Computing the Price of Common Stock: The One-Period Valuation
Model
What is the price for a stock with an expected dividend and price next year of ₹0.16 and ₹60,
respectively? Use a 12% discount rate
Answer:
Computing the Price of Common Stock: The Generalized Dividend
Valuation Model
• Most general model, but the infinite sum may not converge.
Computing the Price of Common Stock: The Gordon Growth
Model
• Same as the previous model, but it assumes that dividend grow at a constant rate, g. That is,
Constant growing annuity formula
Two stage
growth Model
E.g.
• A company paid a dividend of 2.104 in 2013 then the dividend increased at 7% for the next three
years and Then on the growth is 3% thereon. Find the price of the share if the IRR is 10%?
• The first step of this calculation is to determine the values of the first three dividend payments
made between 2014 and 2016, based on the 2013 payment of 2.104 per share and a growth rate of
7%. Then on the growth is 3% thereon.
• D1 = $2.10 * 1.07 = 2.25
• D2 = $2.25 * 1.07 = 2.41
• D3 = $2.41 * 1.07 = 2.58
Rest calculate.
Free Cash Flow method
∞
FCFt
Valuation = ෍ t
1 + rwacc
t=1
Example
Assume WACC =9%, Imagine that the FCF grows 3% till infinity then calculate the value of the Co.
Valuation of the company = 1933941+6866667 = 8800607
Year FCF 1 + 𝑟𝑤𝑎𝑐𝑐 𝑡 PV of FCF

2016 400,000 0.917431 366972.5
2017 450,000 0.84168 378756
2018 520,000 0.772183 401535.4
2019 560,000 0.708425 396718.1
2020 600,000 0.649931 389958.8
Addendum
Calculate the FCF
• Method 1
Addendum
Calculate the FCF
Method 2
• CAPEX = PP&E (current period) –
PP&E (prior period) + Depreciation
(current period)
Cont..
Method 3
• Note: FCFE = FCF – Int(1 – Tax rate)

+ Net borrowing
• FCFE = EBIT – Interest – Taxes +
Depreciation & Amortization –
ΔWorking Capital – CapEx + Net
Borrowing

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Stock Valuation

Prof. Ameet Kumar Banerjee

• Platform for long term borrowing.

• Ownership & Claims of assets of the company.

• Company’s first venture to raise public money.

• The general stock market condition is normal or good.

• Firm commitment underwriting:

Year FCF 1 + 𝑟𝑤𝑎𝑐𝑐 𝑡 PV of FCF

• Note: FCFE = FCF – Int(1 – Tax rate)

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