Question

2. Based on the historical performance of Strava Corporation, you expect earnings and dividends to grow...

2. Based on the historical performance of Strava Corporation, you expect earnings and dividends to grow at a constant rate of 9%. You are considering buying this stock at its current market price of $60. Based on a beta of 1.2, you would require a return of 14% on this stock. The stock just paid a dividend of $4 based on recent accounting statements. How much should you pay for this stock?

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Answer #1

Solution:-

Using dividend discount model, the value of a stock having constant growth rate is calculated using the following formula:

Intrinsic value= Current dividends*(1+growth rate)/(Cost of equity-growth rate)

where,

Current dividends= $4

growth rate= 9%

Cost of equity= 14%

Thus,

Intrinsic value= $4*(1+9%)/(14%-9%) = $87.2

Therefore, the intrinsic value of the stock is $87.2 which means that the stock is massively undervalued at the current price levels of $60 per share, and hence this stock is a great investment to make at these price levels. Further, the investor can pay any price up to $87.2 per share which is the intrinsic value of the stock.

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