Valuation of Common Stocks

Accompanying Files
Study exercises problems
Study exercises answers
Valuation case
Valuation case answers


Managers and investors should consider the following features associated with the valuation of equity:

  • firms are different from individual assets because their lives are not restricted;
  • valuation of common stock uses time value of money concepts;
  • the market price equals the discounted present value of its future dividends and sales price;
  • not all companies pay dividends;
  • one could use free cash flow to value stock.

Managers and investors must have knowledge of the valuation process even if they obtain price estimates from experts such as investment bankers or securities analysts. After all, they cannot monitor - let alone discipline - these experts if they do not understand the basis of their estimates. One must note that cash dividends are the only cash flow a company pays to investors who purchase its common stock. The stock is frequently issued in perpetuity and the company makes no commitment to buy it back, so stockholders must sell their shares in the secondary market to recover their investment. Consequently, the price investors are willing to pay for a share of common stock depends on the dividends they expect to receive and the price they expect to receive when they sell the stock at some future date. However, not all companies pay dividends, or do not pay dividend as much as they could. In cases like these one should look at a broader definition of dividend and use free cash flow to calculate the value of stock.


Partcipants who have completed this workshop, should understand:

  • the basic features of common stock;
  • the valuation process for common stock;
  • the controversy surrounding dividend policy and stock valuation.