Stock Valuation Tutorial in 3 Easy Steps - Stock Value, Valuing Stocks, Finance Stock Valuation
Alright!
Welcome back again to www.MBAbullshit.com.
So our topic for this video is Stock Valuation or how to value stocks or how valuable is
a stock or a share of stock.
Remember, you can always go back to www.MBAbullshit.com to check out more cool videos on these business
topics.
Before this video, you should already understand Future Value, Present Value, Net Present Value,
Value of a Perpetuity, and Value of an Annuity.
If you don’t understand those yet, then you may watch my other free videos on these
topics above.
Alright, let’s get down to it.
First of all, just a quick overview, a “Stock” or a “Share of Stock” is a piece of paper
which says that you own part of a company or corporation, whatever.
You can buy this stock or sell this Stock to somebody else and usually you do this in
a “Stock Exchange” which is a place where people buy and sell stocks from each other.
Or buy from each other, sell to each other.
Alright?
Now the “Stock Value” which we are going to compute in this video is different from
the stock’s “Market Value” which is the price that people actually and really
pay for.
Actually, price at which people actually buy and sell stocks in the real stock exchange.
So you might wonder why on earth are we going to compute this if it’s different from the
actual “Market Value” that people buy and sell stocks.
And the answer to that is we compute the “Stock Value” so that we know if the Stock Market
Value is cheap or expensive at a given time.
So if for example today, a stock is being sold in the market for $10, we can first compute
the “Stock Value” so that we know if ten dollars is too expensive or very cheap and
a good bargain.
Alright?
So that’s why you want to compute the “Stock Value.”
So now, where does the Stock’s value come from?
Where does it come from?
Well, first of all, it comes from the share of profits that it pays out to you.
So if you only share a stock and the company makes money
and you own a part of that company by owning a share of stock of that company then the
company will pay you a share of its profits.
And this share of profits is called the “Dividends.”
Alright?
Now, the second main place where the stock’s value comes from is the price that you can
sell the stock in the future.
So remember, I said you can buy this stock and you can also sell it to somebody else
if you don’t want to own it anymore or if somebody offers you a good price for it or
you can sell it in the stock market or the stock exchange if it’s being sold at a good
price.
Alright?
So that’s where the stock’s value comes from.
Now let’s say a stock is now selling in the stock exchange at twenty four dollars
per share and it has a dividend of two dollars per year.
You plan to sell it after three years.
In three years, the price of the stock is expected to go up to twenty five dollars.
So let’s just say that the discount rate, remember Net Present Value and Present Value
we have a discount rate which is usually the bank rate or the amount of interest you would
get from the bank.
But in terms of stocks, it’s not necessarily the bank rate.
Just call it a “Discount Rate” but we use it in a similar way.
I will show you in a while.
So the discount rate is eleven percent.
So now, what is the value of the stock?
So now we use the Net Present Value formula.
The Stock Value is two dollars.
Remember you’re keeping the stock for three years and you earn two dollars every year
in dividend.
So the value of the stock comes from your two dollars in the first year plus your two
dollars in the second year plus your two dollars in the third year.
Plus the value of the stock also comes from the amount of money you will get in the future
when you sell it and we know it is twenty five dollars.
You see?
And then remember using Net Present Value formula, we have to discount or we have to
bring back the values of these cash flows, okay?
Until today so this two dollars you earn one year later, you have to bring it back one
year.
One.
And you bring it back one year using the discount rate.
So in the basic Net Present Value formula, we bring it back using the bank interest rate.
But with stocks we bring it back using what we call an “Expected Rate” or a “Required
Return.”
We call it a “Required Return.”
If you want to know more about that, you can watch my other video on CAPM or the “Capital
Asset Pricing Model” in another video.
But for now, if you do not know the Capital Asset Pricing Model, no problem, just believe
me when I tell you that we will use a “Discount Rate” of eleven percent instead of the bank
rate.
The bank rate might be lower, maybe five percent or whatever.
Some professors will call it “Discount Rate.”
Some professors will call it “Expected Rate.”
Some professors will call it a “Required Return.”
Alright?
So it doesn’t matter.
The point is that they will give you a certain percentage which you will use in the Net Present
Value formula so that you can bring back these values.
One.
Two.
This is negative three years.
One, Two, Three.
Okay?
So that you can use it in the same Net Present Value formula to find out the value of this
stock today.
Alright?
So this is two dollars every year in dividends and this is twenty five dollars at which you
will sell the stock in the future.
This is the Discount Rate so that you can bring back the value using the Net Present
Value formula.
This is negative one because it happens one year from now so we have to bring it one year.
One.
This is negative two because it happens two years from now so to get the value today,
you bring it back two years.
One.
Two.
This is negative three for the same reason.
One.
Two.
Three.
And then also in the third year, you sell it for twenty five dollars, you have to bring
it back three years as well.
One.
Two.
Three.
Alright?
So just take note, that in this case these are both negative threes, right?
It is not negative three and then negative four because you get the dividend of two dollars
per year for three years and you also plan to sell it after three years.
So you sell this at more or less the same time that you get your last dividend.
Okay.
So now, using the Net Present Value formula, you get the Stock Value of twenty three dollars
and seventeen cents.
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