4.3 Stock Valuation Basics

Valuation of common stock is perhaps legal valuation's most prominent art form. And, as we've been observing, "value, like beauty, is in the eye of the beholder."

This section describes the characteristics of common stock and considers the basic discounted cash flow methods for valuing common stock. It combines time value of money (chapter 1) and risk and return concepts (chapter 2) to estimate the present value of the business's expected income or earnings. What is the present value of the discounted returns? (In later sections we consider asset and market methods of valuation, as well as the effect of liquidity and control rights.)

This section concludes with a look at the competing interests of stockholders and bondholders.

4.3.1 - Characteristics of common stock

Common stock represent an investment interest that combines uncertain rights to dividends and distributions, with voting rights and broad liquidity rights. Its value is based on cash flows, namely dividends. (More 4.3.1>>)

4.3.2 - Basic stock valuation

To value common stock , we turn to the basic DCF stock valuation formulas, assuming first zero growth and then constant growth. (More 4.3.2>>)

4.3.3 - Stock valuation experts (role of stock analysts)

Following recent accounting scandals, Wall Street research analysts came under intense scrutiny for their failure to discern something was amiss. And analysts who followed the high-tech sector have been criticized for falling prey to the tech-stock hype. (More 4.3.3>>)

4.3.4 - Corporate decision-making and stock value

In making business decisions, it is often said that corporate managers are supposed to maximize shareholder value. How do managers know whether their business decisions are maximizing shareholder value? (More 4.3.4>>)

4.3.5 - Relationship between stockholders and bondholders

A tension exists between the stockholders and bondholders of a company. Increases in the holdings of one often come on the backs of the other. Returning to the RJR LBO, we see an example of this reallocation of value. (More 4.3.5>>)