Page 143 - DCOM504_SECURITY_ANALYSIS_AND_PORTFOLIO_MANAGEMENT

Security Analysis and Portfolio Management

Notes
Example: The market P/E is 10 and earnings (dividend) growth rate is 9%. If individual
stocks were to grow at 12%, normal earnings at the end of financial year were 4, projected
earnings volatility was 10% and projected dividend pay out ratio was 15%, determine the value
of the stock.
Solution:
1. Market P/E = 10
2. Market payback period
Given a growth rate of 9% expected earnings stream would be 1.09, 1.88, 2.95 and 29 on. It
will add up to 10 in 6.99 years.
3. Individual stock growth rate = 12%
In 6.99 years, it is worth 11.3 /(expected earnings stream would be (1.12, 1.25, 1.40 and so
on).
4. Projected earnings volatility = 10%
Premium for earnings volatility = + 15%
13.6%
Discount for dividend payout ratio =
+ 1.4%
Net premium

5. Adjusted stock P/E = 11.3 × 101.4/100 = 11.45
6. Normal value of stock = Normal Earnings × P/E
= 4 × 11.45 = 45.8

4.3.6 Growth Stocks

Investors are interested in not only current dividends but also in future earnings through
dividends and capital gains.

Characteristics of Growth Stocks
The following features help identify growth stocks.
1. Substantial and steady growth in EPS
2. Low current DPS, because retained earnings are high and reinvested.
3. High returns on book value

4. Emphasis on R&D
5. Diversification plans for strategic competitive advantage
6. Marketing competence and edge.

Benefits
Investment in growth stocks would benefit investors in many ways.
1. The market value goes up at a rate much faster than the rate of inflation.

2. Higher capital gains.
3. Long range tension free holding without any need for sell & buy operations and associated
problems.

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