Day 62 in MIT Sloan Fellows Class 2023, Managerial Finance 5, Stock
Earning means what?
Earning in accounting means nothing in finance.
We need to dive into detail if we want to find out how to evaluate stock pricing and company's growth.
Trade-off between growth and dividends
There is a trade-off between (1) growing the firm and (2) paying out to the investors
You need to carefully set an optimal allocation to dividends and retained earning.
For example, if ROE < discount rate, share price would be lower than book value if you set high plowback rate.
Terminologies
- EPS: Earnings per share ROE * BV
- ROE: Return on Equity
- Plow back rate: how much you allocate EPS to company growth.
- Payback rate : how much you allocate EPS to dividends.
Organic growth process
So, in this structure, Plowback and Payback mean exactly the allocation between dividends and company growth.
Share price is NPV of dividends
Then, we can calculate terminal value of dividends.
This is the share price.
We need to take care of the time frame because stock price at time=0 was determined by dividends at time = 1.
EV and company value
MV of Equity = Value of operations (PV of all future FCFs) + Non−operational assets − Debt = NPV of dividends
