Time Value of Money
Kinds of Interest Rates
Future Value of an Uneven Cash flow
Security Market Line
Cost of Capital
The Balance Sheet
Hall of Fame
Stock Valuation - see our disclaimer
What is the value of Preferred Stock?
This is easy. Preferred stock is basically a perpetuity.
What is the value of Common Stock?
This is not easy. This is a mess. Think about it. What is the value of a share of stock in a specific company? In one sense it is the price the stock trades at. Both the buyer and seller agree to exchange the stock at that price.
The Gordon Growth Formula, also known as The Constant Growth Formula assumes that a company grows at a constant rate forever. This, by the way, is impossible. I mean, it can't grow forever. You know, if a company doubles in size every 5 years, pretty soon every single person in the world is their customer and then they can't grow at that rate anymore. (because the world population isn't doubling ever 5 years).
BUT, if we go ahead and assume that a company has a constant growth rate, we can use the following formula to get its value.
What is all this D1 and D0 stuff ?
Well we are assuming that the company has constant growth, right. So we take the last divided, multiply it by the growth rate and we can get the next dividend.
First figure out D1.
Next us the formula.
So, if we want to get a 10% rate of return on our
money, and we assume that the company will grow forever
at 5% per year, then we would be willing to pay $21.00
for this stock. That is the theory anyways. And again,
here is our disclaimer.