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Archive for the ‘Equity Analysis’ Category

Valuation of Equity Shares: Dividend Discount Model (CFP)

Posted by Prashant Shah on September 2, 2011

Value  is what we perceive and price is what we pay. Valuation is the process to know the worth of the thing for which we pay a price. It a process through which we can refine our investment decision and it also serves a base to buy an asset.

  • Valuation means present value of all the future benefits
  • Financial theory says that the value of a stock is worth all of the future cash flows expected to be generated by the firm, discounted by an appropriate risk-adjusted rate
  • According to the DDM, dividends are the cash flows that are returned to the shareholder

Zero Growth Model

This model assumes that there will be no growth in the dividend paid by the company and the company will pay the same dividend every year. This means that there is a 100% Dividend payout ratio and no retention of dividends.

Valuation:

Constant Growth Rate Model (Gordon Model)

A model for determining the intrinsic value of a stock, based on a future series of dividends that grow at a constant rate. This model assumes the constant growth rate over the long term.

Valuation:

 Limitations:

  • Applicable to those firms which pay dividend
  • Applicable only to those firms that are growing at a steady growth rate
  • If the growth rate is equal to the required rate of return the price of the stock approaches to infinity

Posted in CFP, Equity Analysis, Investment Planning | 1 Comment »

Introduction to Equity Investment

Posted by Prashant Shah on February 17, 2011

What is Equity?

In simplest words we can say that equity means ownership. An equity share is commonly referred to as ordinary share and it represents the form of fractional ownership in which a shareholder is a fractional owner where they undertakes the maximum entrepreneurial risk associated with a business or a company.

Types of shares:

Apart from the ordinary share of a company, shares can be further classified into

Rights Shares: Rights shares are the shares which are offered to the existing share holders normally at a price which is lower than the current market price of the shares. One of the prime reason for the rights issue is to reduce the cost of raising money to the company.
 
Bonus Shares: These are the shares which are offered to the existing shareholders without any cost. Theoretically bonus issue should not change wealth of the shareholder of the company because when the shares are received there should be relevant decline in the share prices. Some of the reasons for bonus issue are to capitalize the reserves of the company, to bring share price once again in reach of the normal investors and to act as anti takeover measure in certain cases.
Preferred Stock/ Preference shares: These are the shares which are paid fixed dividend. They have a preference over  ordinary shareholders in claiming dividend from the profit of the company. They are different from ordinary shares because they don’t carry voting right and they are redeemable.
 
Cumulative Preference Shares: If the company doesn’t have adequate profit in a particular year the claim of preferred holders are carried forward to next year. Hence these are cumulative preference shares.
 
Cumulative Convertible Preference Shares: These are the preference shares which are converted in to ordinary shares of the company at the time of maturity
 
Warrants: Warrant are normally attached with the debt instruments. The holder of the warrant has a long-term right to buy ordinary shares at fixed price on the fixed future date. Warrants are normally issued with the debt instruments to lure investors.
 
The investors in the equity market can be classified as follows:
Investor: He is the person who invests in a company with long-term investment objective. He wants to profit from the growth of the company. His risk and returns are proportionate.
 
Speculator: He is the person who loves to bet on the prices of the share. His investment horizon is short. The level of risk which he assumes and the returns which he gets is not proportionate.
 
Arbitrager: They are mainly involved in the market to make risk free profits. They buy from one market and sell in other market as and when price discrepancy arises.

Posted in Equity Analysis | 2 Comments »