Chapter 9: Valuing Stocks
9.1 The Dividend-Discount Model
● One-Year Investor
○ There are two potential sources of cash flows from owning a stock
■ They might pay out cash to its shareholders in the form of a dividend
■ The investor might generate cash by choosing to sell the shares at some
future date
○ The present value of stocks is calculated using the equity cost of capital rE which
is the expected return of other investments available in the market with
equivalent risk to the firm’s shares.
○ Buying or selling a stock must be a zero-NPV investment opportunity.
● Dividend Yields, Capital Gains, and Total Returns
○ The dividend yield is the expected annual dividend of the stock divided by its
current price.
■ The dividend yield is the percentage return the investor expects to earn
from the dividend paid by the stock
DIV1 / P0
○ The capital earned is what the investor will earn on the stock, which is the
difference between the expected sale price and purchase price for the stock, P1 -
P0.
■ This is divided by the current stock price to express a percentage known as
the capital gain rate.
p1 - p0 / P0
, ○ The total return is the sum of the dividend yield and the capital gain rate and is
the expected return that an investor will earn for a one-year investment in the
stock.
○ The expected total return of the stock should equal the expected return of other
investments available in the market with equivalent risk.
■ If a stock offers a higher return than other equally risky investments,
people will buy the stock.
■ If a stock lowers its expected return, investors will sell the stock.
● A Multiyear Investor
● The Dividend-Discount Model Equation
○ This equation holds true for a single N-year investor, who will collect dividends for
N years and then sell the stock
○ The price of the stock is equal to the present value of the expected future
dividends it will pay.
9.2 Applying the Dividend-Discount Model
9.1 The Dividend-Discount Model
● One-Year Investor
○ There are two potential sources of cash flows from owning a stock
■ They might pay out cash to its shareholders in the form of a dividend
■ The investor might generate cash by choosing to sell the shares at some
future date
○ The present value of stocks is calculated using the equity cost of capital rE which
is the expected return of other investments available in the market with
equivalent risk to the firm’s shares.
○ Buying or selling a stock must be a zero-NPV investment opportunity.
● Dividend Yields, Capital Gains, and Total Returns
○ The dividend yield is the expected annual dividend of the stock divided by its
current price.
■ The dividend yield is the percentage return the investor expects to earn
from the dividend paid by the stock
DIV1 / P0
○ The capital earned is what the investor will earn on the stock, which is the
difference between the expected sale price and purchase price for the stock, P1 -
P0.
■ This is divided by the current stock price to express a percentage known as
the capital gain rate.
p1 - p0 / P0
, ○ The total return is the sum of the dividend yield and the capital gain rate and is
the expected return that an investor will earn for a one-year investment in the
stock.
○ The expected total return of the stock should equal the expected return of other
investments available in the market with equivalent risk.
■ If a stock offers a higher return than other equally risky investments,
people will buy the stock.
■ If a stock lowers its expected return, investors will sell the stock.
● A Multiyear Investor
● The Dividend-Discount Model Equation
○ This equation holds true for a single N-year investor, who will collect dividends for
N years and then sell the stock
○ The price of the stock is equal to the present value of the expected future
dividends it will pay.
9.2 Applying the Dividend-Discount Model
