Essay: Stock Price Valuation

Sample Essay

The expected value of stock can be determined through several techniques which include Price to Earnings Ratio – P/E ratio, discounting of expected future dividends and discounted expected future free cash flows. The common factor in the last two methods is dependence on expected future values instead of current financial statement of market values. Expected future values of dividends or cash flows are estimated by implementing an appropriate growth rate. The P/E ratio on the other hand estimates the stock price based on earnings per share. The main question is whether two investors should pay the same price for a stock or not. The answer to this question is in the affirmative when the two investors expect the pattern of future dividends to be similar based on a similar growth rate.

The dividends discounts model approach uses expected dividends, a discount rate such as cost of common stock and a growth rate to arrive at a current price of the stock. If there is a difference in the growth rate, expected future dividends or discount rates the dividend discount model would yield different stock prices for the two investors. The difference in time periods for estimation of stock prices would not be considered substantial as both investors would discount the future dividends to present values which would be similar.

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