STOCK VALUATION - the estimated fair value of the assets of a company

is compared to the market price to determine if the

-used to make investment decisions stock is fairly priced in the market (can be cheap or
rich)
-used as a guide for investors to know the value of
stocks easier (can be undervalued or overvalued) *Cheap price is when the market price is below the
estimated fair value
*Undervalued stocks judged with respect to their
theoretical value are bought *Rich price is when the market price is above the
estimated fair value
*Overvalued stocks on the other hand are sold, in
the expectation that undervalued stocks will overall - traditional fundamental analysis has several
rise in value while overvalued stocks will generally limitations as it does not quantify the risk factors
decrease associated with a stock and how those risk factors
affect its valuations
-is the method of calculating theoretical values of
companies and their stocks. *In a perfectly efficient market, all securities are
always correctly priced. The market price equals to
-used to predict future market prices, i.e. the
the fundamental value, or the intrinsic value which
potential market prices which will give the highest
is the cornerstone of fundamental analysis, of the
possible return for investors
security.
*Predicting possible market prices leads to a good
*In a partially inefficient market, the market prices
judgment, thus giving rise to profit from price
deviate from the fundamental value.
movement
*Investment analysts are the ones typically charged
with trying to determine the intrinsic value of a
TWO APPROACHES IN STOCK VALUATION stock. They want to figure out what it is really
worth to investors, because its historical costs
1. Fundamental Analysis seldom reflect its actual market valuation.
2. Technical Analysis
*Financial analysts aim to discover the fundamental
value ahead of the rest of the market participants
before the market prices approach the fundamental
FUNDAMENTAL ANALYSIS value in order to make profits. The actions of such
-involves the analysis of a company’s operations to profit-seeking investors push the market towards
assess its economic prospects efficiency.

-based on fundamental financial characteristics (e.g.

earnings) about the company and its corresponding TWO MOST COMMONLY USED METHODS
industry
1. Dividend Discount Model
*The overall industry of a certain company often
affects and influence its stock values -assumes a stable dividend growth rate in
dividends year after year.
-analysis is based on financial statements of the
company in order to investigate the earnings, cash 2. Price/Earnings Model
flow, profitability, and financial leverage
-takes the earnings per share of a company
*Includes analysis of the major product lines, the and multiplies it by the price earnings ratio
economic outlook for the products, and the
industries in which the company operates -has the benefit of simplicity and
straightforwardness
-results in projection of earnings growth
- a bottom up valuation technique
Dividend Discount Model
*All securities can be valued by calculating the
present value of their future cash flows.
*Rather than make investment decisions based on 1. CONSTANT DIVIDEND GGM
“top down” macroeconomic, social and political
Formula: P = D / r
changes, the analysis concentrates on the company
concerned. Where: P = current stock price/intrinsic value
D = expected dividend
 r = discount factor/rate of return Ex: AZ has paid consistent quarterly dividends for
years. However, its dividend growth slowed in the
Ex: A company which stock is trading at P1,000
2015 fiscal year, making a one-stage DDM
requires an 8% minimum rate of return. The said
unsuitable for accurate valuation. For 2011-2014,
company currently pays a P150 dividend per share.
AZ had 7% dividend growth rate while the 2015
Formula: P = D / r growth rate of 3% is used as the projected future
D1 / (r+1)1 + D2 / (r+1)2 + D3 / (r+1)3 + ….. + DN (1+G2) / (r-G2) / (r+1)N
rate. On 2011, the payment was P2.10 per share and
Solution: the required rate of return is 10%. The latest trading
P = 150 / .08 amount of the stock is P45.

= P1,875 Formula: P =

Thus, the stock which is trading at P1,000 is Solution:

overvalued by P875.
First Step: Determine the values of first three
dividend payments, i.e. 2012-2014, based on the
2011 payment of P2.10, and the 7% dividend
growth rate.
D1 = P2.10 x 1.07 = P2.25
D2 = P2.25 x 1.07 = P2.41
2. CONSTANT DIVIDEND D3 = P2.41 x 1.07 = P2.58
GROWTH/GORDON GROWTH MODEL
Formula: P = D / r – g
Where: P = current stock price/intrinsic value
Second Step: Substitute the Values
D = expected dividend
D1 / (r+1)1 + D2 / (r+1)2 + PD3=/ (r+1)3 + ….. + DN (1+G2) / (r-G2) / (r+1)N
r = discount factor/rate of return
= P2.25 / (0.10+1)1 + P2.41 / (0.10+1)2 + P2.58 /
g = constant growth rate expected for (0.10+1)3 + P2.58(1+0.03) / (0.10-0.03) /
dividends, in perpetuity (0.10+1)3
Ex: Company AAA has a minimum rate of return of = 2.25/1.10 + 2.41/1.21 + 2.58/1.331 +
12% and currently pays a P100 dividend per share, 2.66/0.07/1.331
which is expected to increase by 5% annually. The
= 2.05 + 1.99 + 1.94 + 28.55
stock is currently trading at P1,500
= P34.53
Formula: P = D / r – g
Thus, the stock which was trading at P45 is
Solution: undervalued by P10.47 (P45-P34.53).
P = 100 / 0.12 – 0.05
= P1,429 PRICE/EARNING MODELS
Thus, the stock is undervalued by P71. 1. Trailing P/E Ratio

Formula:
3. TWO-STAGE GROWTH MODEL Earnings Per Share = Profit / Total Shares
Formula: P = D1 / (r+1) + D2 / (r+1) + D3 / (r+1) + ….. + DN (1+G2Outstanding
1 2 3
) / (r-G2) / (r+1)N
P/E Ratio = Market Value Per Share /
Where D = Dividend Payments Earnings Per Share
r = rate of return Ex: BZ Inc.’s profit for the fiscal year 2017 was
DN = most recent dividend payment P13,640,000 while the outstanding shares was
3,100,000. The company’s closing price closed at
G2 = Growth Rate P85.45. What is the P/E ratio?
N = number of periods
Earnings Per Share = Profit / Outstanding Shares
 = P13,640,000 / 3,100,000 =
P799,087+P633,848+P628,364+P646,884
= P4.40
= P2,708,183
P/E Ratio = Market Value Per Share / EPS
*The higher the DCF, the better.
= P85.45 / P4.40
2. Price-to-Book Ratio / Price-Equity Ratio
= 19.42x
2. Forward P/E Ratio Formula: Book Value Per Share = Book
Value / Shares Outstanding
Formula: PB Ratio = Current Price per
P/E Ratio = Current Share Price / Estimated Share / Book Value Per Share
Future EPS
Ex: BZ Inc.’s profit for the fiscal year 2017 was Ex: Assume that a company has P100,000 in
P13,640,000 while the outstanding shares was assets and P75,000 in liabilities on the balance
3,100,000. The company’s closing price closed at sheet. As of end of the year, there are 10,000 shares
P85.45. Furthermore, it is estimated that the EPS outstanding. The market price of each share is P5.
will increase by 45% over the next year. What is the What is the P/B Ratio?
P/E ratio?
Solution:
Est. EPS = P13,640,000 / 3,100,000 BVPS = 100,000-75,000 / 10,000
= 25,000 / 10,000
= P4.40 + (P4.40x0.45)
= P2.5
= P6.38 P/B Ratio = P5 / P2.5
= 2x
P/E Ratio = P85.45 / P6.38 *A lower P/B ratio could mean the stock is
= 13.39x undervalued, and the reverse holds true.

* A P/E ratio of 40 is really high, a P/E ratio of 7 is 3. Debt to Equity Ratio

really low, and a ratio of 14 represents the average
over modern history. The higher the ratio, the
greater the amount an investor is willing to pay for Formula: D/E = Total Liabilities /
P1 of current earnings. So a stock with high P/E is Shareholders’ Equity
expected to increase in value.
Ex: CJ Company had total assets of
OTHER FUNDAMENTAL ANALYSIS
METHODS P25,000,000 as of the end of 2019. 65% of it is
financed by debt. What is the debt to equity ratio?
1. Discounted Cash Flow Model
Solution: Liabilities = P25,000,000 x
Formula: DCF = CF / (1+r)1 + CF / (1+r)2 + 0.65
CF / (1+r)3 …. = P16,250,000
Where CF = Cash Flows each period ShEq = P25,000,000 x 0.35
= P8,750,000
r = rate of return D/E Ratio = P16,250,000 /
Ex: GGFM Inc.’s cash flows for the fiscal P8,750,000
years 2016-2019 were P875,000, P760,000, = 1.86x
P825,000, and P930,000, respectively. The 4. Price/Earnings to Growth (PEG) Ratio
rate of return is 9.5%
Formula:
1 2
Formula: DCF = CF / (1+r) + CF / (1+r) + EPS Growth Rate = (Current EPS / Previous
CF / (1+r)3 + CF / (1+r)4 EPS) - 1
Solution: PEG Ratio = Price/EPS / EPS Growth Rate

DCF = 875,000 / (1+0.095)1 + 760,000 / Ex: GD00 Co. revealed that their EPS from
(1+0.095)2 + 825,000 / last year which was P4.60 increased by 70% this
(1+0.095)3 +
year. The stock is currently trading at P32 per share.
930,000 / (1+0.095)4
What is the PEG ratio?
 Solution:
Price per share = P32
EPS Last Year = P4.60
EPS This Year = P7.82
(4.60+(4.60x70%))
Trailing P/E Ratio = P32 / P7.82 = 4.09
Earnings Growth Rate = 70%
PEG Ratio = 4.09/70 = 0.06

*When a company’s PEG exceeds 1.0, it is

considered overvalued while if it is less than 1.0. it
is said to be undervalued.