 Personal finance practice problem using OneNote. Stock price calculation assuming constant dividends and no growth. Prepare to get financially fit by practicing personal finance. You're not required to, but if you have access to OneNote, would like to follow along. We're in the icon left-hand side, practice problems tab in the 12 to 10 stock price calculation assuming constant dividends and no growth tab. Also take a look at the immersive reader tool practice problems typically in the text area too with the same name, same number, but with transcripts. Transcripts that can be translated into multiple languages either listened to or read in them. We're thinking about investment strategies in stocks. Stocks representing an ownership interest in a corporation. Corporations being separate legal entities where the ownership interest is broken out into standardized units of shares or stock. We're also typically thinking about publicly traded companies. Those traded on public exchanges making them more transparent, more accessible allowing us to get to things such as their financial statements to make investment type decisions. Also keep distinct in your mind your investment strategies you might use for investing in stocks versus investing using tools like mutual funds and ETFs. We're focusing here more on investing in the individual stocks or so we're analyzing then individual companies as you're investing say in individual stocks you've gotta think about how they fit or align with your overall portfolio. So we're gonna be looking at then valuing how can we value in essence the price of the stock? How can we guess or estimate what the value of the stock is? Possibly then being able to compare that to what the market price is what the price is determined by supply and demand by the market to see if it's under or overvalued to help us out with our investment strategies. We wanna use a concept oftentimes that's similar to what we use for investment in fixed income such as bonds. That being, we would like to kind of value in the future cash flow streams take a present value of the future cash flow streams and that can help us to determine what the value of the investment would be. That's straightforward to do in essence with bonds because with a bond we have two standard investment flows that being that we're gonna have the interest which is typically semi-annual going out into the future and then we've got the maturity date which is known because it's in the bond and then we're gonna have that amount that we're gonna get back basically the principle at the end of the bond. So we can present value using the market rate and that's kind of the confusing component there to choose what rate would be the appropriate rate but we can discount it back to the future and that can help us to determine what the price is. When we're thinking about the common stock it's more difficult because we have two formats of income that we are expecting to get in terms of a return on the stocks. One would be the return in the form of dividends the company giving us dividends meaning they're gonna generate revenue and they're gonna give us those revenues similar to a draw when you're talking about a partnership or a sole proprietorship but in a partnership or sole proprietorship the partners can take different draws. So in a corporation all the stocks have to be the same therefore the partner or the stockholder does not determine directly what the dividend will be that's gonna be determined by the board of directors and management but that would be the return of the revenue of the company in the form of a dividend distribution and then the other way would be that they invest in the company they grow the company and in so doing that should be reflected in the stock price. So we've got these two kind of things that are going on. We also wanna think about the kind of stock that we're investing in when we're using this kind of strategy. So it's easier to use this kind of strategy if you're thinking about and here we are thinking about well-established companies. So a company will typically have kind of an arc in their growth, right? So it's gonna look something like this if they survive all the way through, right? So we're gonna say when they're down here they're in the growth area they're probably not gonna be giving much dividends because they're reinvesting in the company and that means that their stock price might go up so you can think about Apple when it was growing and then at this point in time up here now they've been well-established they don't need to make new plans so you can think of like Apple now that's pretty well-established or you can think of like a utility company for example all the plants are built the phone company for example all the phone lines are out there they don't need to build more phone lines and whatnot but you would expect that they're gonna march along pretty consistent in their revenue and therefore they're gonna give most of that revenue back in the form of dividends. So if we're gonna analyze the future cash flow streams that's kind of the easiest way to do it we're gonna say here that we're looking at a company that doesn't have a lot of growth because they're at the peak of their growth spurt here and they're just well-established like utility companies now for example but we expect them to keep marched along with a standard kind of dividend. Now you could use the same strategy for other kind of companies as well but it gets a little bit more complex and we'll talk about that in future presentations so that's gonna be the assumption we're gonna make here we're looking at common stock value no growth so they're giving common stock, standard stocks now remember that in your investment strategy typically people that are like in retirement for example are gonna want a standard dividend kind of stock oftentimes so these are often more stable kind of stocks and when you're younger investing for retirement or have a long time horizon then you're probably a more balanced portfolio you've got more stocks that are down here somewhere looking for that maximizing of the growth for example but also having diversification. Okay but here we're looking at at those established like utility kind of companies and we're gonna value them. Now that means that we're gonna value the dividends that are going out into the future we're gonna assume that the dividends are $15 and they're just gonna be a plan to keep this dividend for some time into the future we're gonna say that that's gonna be standard so utility company they're just gonna crank out the dividend and that we don't expect them to grow that much we just expect them to march along doing what they're doing and giving that dividend out into the future. So it would be kind of like looking at a bond and valuing just like the interest payments instead of not having to deal with the principal at the end except that the interest payments have a maturity date whereas here the dividends could in theory go out forever. However, as we'll see those payments out into the future at some point will be somewhat small in relation to the overall price so we can use it kind of this method. So required rate of return for the common stockholder we're gonna say is 12 that's the market rate that's what we think we can get on say similar risk investments for example so that's the rate that we need to clear in essence in order to be invested in the stock. So what would the price be? The easy calculation we could say it's just gonna be $15 and then we're gonna divide it by the 12% and then we get the 125. So that's easy to calculate might not be as satisfying to kind of understand there's the 125 and so we'll analyze it a little bit more we can also think okay well if the price is 125 and my required rate of return let's say the price that we found was 125 and I need a required rate of return of 12 and we think that this is just a dividend stock that's gonna go up in the future not a whole lot of growth then we can of course calculate the dividend that we would expect them to have 125 divided by 0.12 I'm sorry times 0.12 125 times 0.12 would be the 15. Okay let's see if we can understand that a little bit better we could say okay well I could think of this as an annuity remember when we price a bond we usually price a bond by taking the present value of the interest and then we take the present value of the maturity amount. Now in this case we don't have a maturity amount so it's just the present value of the annuity so we could do an annuity calculation this is what it looks like in Excel we do do this in Excel if you wanna take a look at it and we could say okay it's the present value of the rate that's gonna be our discount rate the 12% the number of periods we don't know that because there's no maturity date here but we're expecting that 15% to go on for some time into the future so we'll just in essence it could go on to infinity in theory but we'll just pick a large number like 100 so that's way out into the future and then comma the payment then is gonna be that $15 of the dividend so if we look at an annuity for 100 years at the $15 dividend that's gonna get us to that 125 that we've got to here so that's how we're kind of discounting the stream you can also think about it this way we could say okay well what if we mapped this out as future cash flows that we're expecting from the company and you can also do this if you expect the dividends to change over time you could allow for that changes by just mapping out each year and say what would the dividends be per year and then discount it just basically on a year by year basis so we could say okay let's take this out 15 years they're gonna be $15 dividend per year if I discount that here's the first one if I discount that $15 back one year at 12% using a present value of one formula in other words it would be the rate 12% number of periods this time is just one because we're taking that 15 one period back to the present comma comma because there's no payment it's not an annuity but just a present value of one future value would be then the 15 discounting that 15 back at 12% one year would give us the 13, 39 about if we discount year two $15 two years back at 12% we get the 11, 95 and so on and so forth and you can see that as we go out into the future that 15 of course into the future because of the time value of money is gonna get smaller and smaller and when we get way out here close to the 100 year frame you can see that the 15s are getting small to the point that remember we said this could go out kind of indefinitely but now this number is fairly small it has a fairly small impact on the price and so that's why when I use 100 years we can basically kind of get to a price if I sum all these up then we get to that 125 again so you gotta be a little bit careful with some of these annuities depending on how big the dividend is because you know but that's gonna be the general idea so we can still use that valuation method that we would have in a bond even though we don't have a set terms and try to attempt to get that same method now in Excel you might do the same method this way put the periods this way put the headers up top I highly recommend practicing these things in Excel because you wanna practice your tables you wanna practice the present value calculations and you wanna see the difference between a table like this where you've got the advantage of being able to put your headers and having more space on the headers whereas here you got your headers up top so if you want a long header you gotta have multiple cells or you gotta wrap the cells or something but you can copy the information down a lot more easily by just double clicking for example on the fill handle and you can copy the present value calculation down more easily so now we're just mirroring this calculation here the 15 being present value one year back at the 12% gives us the 13, 39 and so on and so forth and we do the same calculations thusly so we would then get after 100 years 1,500 in dividends $15 a year for 100 years but after we discount it there's only 125 now also just realize that that discount concept is a little bit confusing because we discounted it not at the interest rate here this isn't like inflation this is the rate that we think we can get on other investments this is kind of like the hurdle rate if you would think about it in terms of like investing in capital investment calculations if you've done that kind of thought process so in other words you might say let's look at the cash flows including the price meaning if I put the $125 up front and I present value that it would be at the 125 and then if I took the 15s all the way through and added that up it would get to zero meaning and the reason I point that out is because when you do a hurdle rate hurdle rate calculation this would be the full cash flow right we put the cash flow of 125 up front which is equal to 125 at year zero then we discount all of the years going forward and it comes out to zero that doesn't mean that we didn't make a profit that means that we cleared the hurdle rate that means that we cleared if it's over a zero we got a 12% return right if it was exactly zero we got a 12% reserve return if it was higher than zero then we would have got something higher than a 12% return so that would mean that we would want to invest in it because we think that our comparative investment would be a 12% return so in future presentations we'll add a little complexity and say well what if we think the stock price is going to grow too and not just be valuing it based on the future dividends in that case we could try to figure what the dividends will be at some point into the future thinking about it as cash flow way out into the future for example or we could try to take into consideration the growth and the value of the stocks and try to estimate that as well