MODULE 7.

PLATFORMS FOR CAPITAL MARKET

OBJECTIVES
After successful completion of this module, you should be able to:
 Describe how to trade in capital market
 Make their own online trading account
 Identify the advantages and disadvantages of conventional and online trading
 Stock Valuation (use of Market Value Ratios)
 Determine the stock valuation (the use of Market Value Ratios)

COURSE MATERIALS
Platforms for Capital Market
In trading or doing business in capital market, there are different ways on how to
conveniently facilitate the trading in the Capital Market.

Conventional Brokerage
In conventional brokerage, investo4s buy or sell shares by opening an account with a
stockbroker who will then buy and sell shares in behalf of the investor in exchange for payment
of commission. Since brokers are exposed to the working of the stock market, they can provide
sound investment advice to their client-investors on what stock trading decision to take.

Online Trading
This is by way of a digital platform to trade shares. Online brokers typically charge lower
commission compared to conventional brokers; however, they do not offer any investment advice
and other services like a traditional broker.

Mutual Funds
This another form of investment wherein an investor buys shares in mutual funds. Mutual
funds are an investment company that pools money from various investors and invests them to
different securities based on the investment objective of the fund. This is a form of diversification
in investment since mutual funds old shares in different companies.

Market Capitalization
This refers to the total market value of all outstanding shares of a company which allows
investors to benchmark the relative size of a company against another. This is calculated by
multiplying the total outstanding shares by the prevailing market price per share.

Share Valuation
There are various types of share valuation techniques that an investor can choose to
identify how much cash flow can be received in the future by an investor who purchases it today.
The value of a share is equivalent to the present value of the future cash flows that can be received
from an investment. This approach is known as the Discounted Cash Flow approach.

Other share valuations such as:

One Period-Dividend Discount Model (source: https://corporatefinanceinstitute.com/)
The one-period dividend discount variation is used to determine the intrinsic value of a
stock that is planned to be held for one period only (usually one year).

57 | P a g e
The formula is:

or
Where:
 V0 – the current fair value of a stock
 D1 – the dividend payment in one period from now
 P1 – the stock price in one period from now
 r – the estimated cost of equity capital

Example:
Assume that ABC Corp. will pay $3 in dividends per share, while the selling price at the
end of the holding period can reach $120 per share. The estimated cost of equity capital is 5%.
Currently, the stock of ABC Corp. trades at $118 per share.

In order to assess the viability of the investment, you should determine the intrinsic value
of the company’s stock. It can be found using the one-period dividend discount model. By inputting
the known variables into the formula above, the intrinsic stock value can be calculated in the
following way:

The intrinsic value of the company’s stock is $117.14, which is less than the company’s
current stock price ($118). Therefore, we can say that the stock is currently overvalued.

Multiple Period-Dividend Discount Model (source: https://corporatefinanceinstitute.com/)

A multiple-period dividend discount model is a variation of the dividend discount model. It
is often used in situations when an investor is expecting to buy a stock and hold it for a finite
number of periods and sell the stock at the end of the holding period.

Similar to the general dividend discount model, the multiple-period model is based on the
assumption that the intrinsic value of a stock equals the sum of all future cash flows discounted
back to their present values.

58 | P a g e
The formula is:

Where:
 V0 – the current fair value of a stock
 Dn – the dividend payment in the nth period from now
 Pn – the stock price in the nth period from now
 r – the estimated cost of equity capital

Example:
You’ve forecasted that ABC Corp. will pay dividends of $2.50 in the first year, $3 in the
second year, and $3.25 in the third year. You expect that at the end of the third year, the selling
price of the company’s stock will be $125 per share. The estimated cost of capital is 5%. The
current stock price is $110 per share.

In order to assess the viability of the investment, you should determine the intrinsic value
of the company’s stock. It can be found using the multiple-period dividend discount model. By
inputting the known variables into the formula, the intrinsic stock value can be calculated in the
following way:

The intrinsic value of the company’s stock is $115.89, which is more than its current stock
price ($110). Therefore, we can say that the stock is currently undervalued.

Zero-Growth Model
This assumes that the dividend will be fixed and will not change anymore in the future.
The formula is:

Example:
Investor ABC wants to buy 1,000 preference shares, p200 par value from Korean
Company. According to his sources, the preference shares come with a constant dividend of P30

59 | P a g e
per share. Investor ABC intends to hold the preference shares long-term and has no plans on
selling this I the near future. Investor ABC requires a 15% return on his investment. What is the
value of each preference share?

P30
P= 15% P = P200 per share

The value of each preference share of Korean Company is P200.

Assuming that ABC is also looking at the preference shares of Chinese Company that has
par value of P100 with 20% dividend rate. What is the value of each preference share of Chinese
Company?
P20
Dividend P100 x 20% = P20 per share P= 15% P = P133.33 per share

The value of each preference share of Chinese Company is P133.33.

Constant (Gordon) Growth Model (source: Investopedia)

The Gordon Growth Model (named after Myron Gordon) values a company's stock using
an assumption of constant growth in payments a company makes to its common equity
shareholders. The three key inputs in the model are dividends per share (DPS), the growth rate
in dividends per share, and the required rate of return (RoR).

Dividends per share represent the annual payments a company makes to its common
equity shareholders, while the growth rate in dividends per share is how much the rate of
dividends per share increases from one year to another. The required rate of return is a minimum
rate of return investors are willing to accept when buying a company's stock, and there are
multiple models investors use to estimate this rate.

Formula and Calculation of the Gordon Growth Model:

D1
P = (r – g)

where:
P = Current stock price
G = Constant growth rate expected for dividends, in perpetuity
R = Constant cost of equity capital for the company (or rate of return)
D1= Value of next year’s dividends

Example:
Consider a company whose stock is trading at P110 per share. This company requires an
8% minimum rate of return (r) and will pay a P3 dividend per share next year (D1), which is
expected to increase by 5% annually (g).

60 | P a g e
The intrinsic value (P) of the stock is calculated as follows:

P3,00
P = (.08-.05) P = P100.00

According to the Gordon Growth Model, the shares are currently P10 overvalued in the
market.

Variable Growth Model

Four steps involved:
1. determine the value expected cash dividends at the end of each year using the initial
growth rate assumptions. To compute, apply the growth rate assumption on the current
dividend and do the same procedure every year.
2. Compute for the present value of the expected dividends during the initial growth period.
3. At the end of the initial growth period, determine the value of the stock (from that point of
infinity) using the constant growth model.
4. Add the computed present value of the expected dividends during the initial growth period
and the computed value of the stock at the end of the initial growth period.

Example:
Vic Company is contemplating whether to buy shares in Vin Company which paid recently
dividends of P3 per share. After carefully evaluating the business of Vin Company, Vic came up
with the estimate that dividends may grow at 5% annual rate in the next 3 years. At the end of 3
years, Vic expected that the market will mature and organic growth will only lead to a constant
3% dividend growth in the foreseeable future. Vic uses 12% required return in evaluating his
investments.

Compute for the value of the shares n Vic Company.

 Dividend from previous year x (1+growth rate in the initial period = Expected Dividend
Year 1 P3 x 1.05 = P3.15
Year 2 P3.15 x 1.05 = P3.31
Year 3 P3,31 x 1.05 = P3.47

 Present value of dividends expected to be received for each year using require return of
12%
Year 1 P3.15 x 0.8928 = P2.81
Year 2 P3.31 x 0.7972 = P2.64
Year 3 P3,47 x 0.7118 = P2.47

 Value of stock at the end of Year 3 (last year of initial growth period) using the constant
growth model.
Expected dividend on Year 4 : P3.47 x 1.03 = P3.57

D
--------- P3.57
P = (r – g) P = (12%-3%) P = P39.67

The value of the stock at the end of the initial growth period is P39.67.

61 | P a g e
Other approaches to share valuation are:
a. Free Cash Flow which refers to the cash flow that are available to creditors and
shareholders after all other operating obligations.
b. Book Value per Share which refers to the amount per share that will be received if all of
the company’s assets are sold based on its book value where proceeds will go to the
ordinary shareholders after satisfying the creditors and preference shareholders.
c. Liquidation Value per Share which pertains to the actual amount per share that will be
received if all assets are sold based on their current market value where all creditors and
preference shareholders are paid first and the excess will be divided among the remaining
shareholders.
d. Price Earnings (P/E) Multiples which uses the price-earnings ratio to compute for the
share price as basis to determine the value of a company.

ACTIVITIES/ASSESSMENTS
Answer the following exercises:
Exercise No. Mod 7-1 (True or False)
1). Mutual fund is an investment company that pools money from various investors and invests
them to different securities based on the investment objective of the fund.

2). Market capitalization refers to the total market value of all outstanding shares of a company.
This is calculated by multiplying the total outstanding shares by the prevailing par value per share.

3). Market capitalization allows investors to benchmark the relative size of a company against
another.

4). Knowing different share valuation techniques equip investors with the right knowledge that will
help them choose the best stocks that fit their investment appetite.

5). Share valuation techniques are commonly grounded in identifying how much cash flow can be
received in the future if the investor purchases the share now.

6). The constant growth model or the Gordon growth model (named after Myron Gordon) is the
most widely known model used in share valuation.

7). Since future growth rates may go up or down as a result of changes in economic conditions,
a variable growth model was developed to incorporate changes in growth rate in the valuation.

8). The market price of shares signifies the collective actions that sellers and buyers undertake
based on currently available information.

9). Book Value per Share which refers to the amount per share that will be received if all of the
company’s assets are sold based on its book value where proceeds are only for the ordinary
shareholders.

10). Dividends per share represent the annual payments a company makes to its preference
shareholders, while the growth rate in dividends per share is how much the rate of dividends per
share increases from one year to another.

62 | P a g e