Subject: Marketing
Topic: INVESTMENT ANALYSIS
Language: English (U.S.)
Pages: 3
Instructions
Given that Dr. Bueller wants to make stocks a major part of his investment portfolio, you decide to focus on how to analyze stocks. You decide to use a large U.S. industrial company, to demonstrate how to analyze stocks. The research department has provided you with the following information regarding this company. This year (2009), free cash flow is expected to reach $325 million. In 2010, it is expected to reach $350 million. 2011, $400 million. 2012, $425 million And 2013, $450 million. The analyst has projected an intrinsic value for this stock of $65.00. Dr. Bueller is busy this week, so he asks you to send him an e-mail. Compose an e-mail that in addition to explaining the following information for the industrial company, which is a publicly traded company that trades on the NYSE, addresses the efficient market hypothesis, and how the analyst responsible for monitoring this stock has projected this intrinsic value for the company's stock. 52-week range: Hi 75 Lo 35 Current stock price: 50 Dividend Yield: 2.75% Dividend per share: 1.375 P/E ratio: 20 Earnings per share: $2.50 Shares outstanding: 100 million Market capitalization: $5 billion Cost of capital: 9% Growth rate of free-cash-flows beyond 2013: 3% Assignment Guidelines Using the textbook, course materials, and Web resources, find the definitions for the ten values listed above in the Assignment Description. In your own words, rewrite the definition for each of the ten values. Demonstrate how to calculate the values using the information from the company's stock as an example. Next, answer the following questions: What is the efficient market hypothesis, and what is its relationship to stock valuation? What is the free-cash-flow approach to valuing stocks? Using the free-cash-flow approach, how did the analyst arrive at an intrinsic stock value of $65 for the company? Compile your definitions, calculations, and your answers to the three questions above into a single Word document.

Investment Analysis

Definition of Terms

·        52-week range: Hi 75 Lo35

The term ‘52-week high/low’ refers to the highest and the lowest prices that a particular stock has traded at in the last year. The 52 week hi/low is seen as an integral element in determining the stock’s current value. The range can also be useful in projecting the stock’s price movement in the future. The 52- week high and low can be derived by observing the highest price of the stock during the 52-week period and the lowest price for the same stock during the same period.

In this scenario, the highest stock price during the last year was $75 while the lowest price for the stock during the same period was $ 35.

·        Current Stock Price: 50

This is the current price of the stock in question on the market. It can also be defined as the last price of the stock in the market at a particular moment in time. The current stock price for this particular company is $50.

·        Dividend Yield: 2.75%

This ratio is the dividend per share divided by the price of per share. It can also be defined as the company’s total dividend payments divided by the company’s market capitalization. In this case, the total dividends were $137,500,000 while the market capitalization was at 5 billion. Dividing the two figures gives a dividend yield of 2.75%.

·        Dividend per Share: 1.375

The dividend per share is the amount of dividends that the company pays for every share of the common stock over the financial year. Investors view a fall in dividends per share as a sign that the company is not doing well financially. The company’s market value would drop because of the shareholders rush to sell their shares. If the dividend per share increases, then the firm is seen as performing well.

The dividends per share are calculated by dividing the dividends paid by the number of shares outstanding. In this case, the outstanding shares are 100 million while the total amount of dividends issued was $137,500,000. Dividing the sum of dividends by the number of outstanding shares gives us the dividends per share that is 1.375.

·        P/E Ratio: 20

The Price to Earnings Ratio is used to measure the value of a company that measures its current share price in relation to its per share earnings.

The P/E ratio is calculated by dividing the market value per share by the earnings per share. In this case, the current share value is $50 while the Earnings per share are $2.50. When we divide the current share, value by the earnings per share the result is $20, which is this company’s P/E ratio.

The ratio tells investors how much they need to invest in a company so that they can be able to receive a dollar from that company. In this case, the P/E is $20 meaning that an investor should be willing to pay $20 in order to receive $ 1 from the company’s earnings.

 

·        Earnings per Share: $2.50

The Earnings per Share is the income available to the shareholders divided by the number of shares outstanding. It can also be defined as the portion of the profits allocated to each ordinary share. It is derived by dividing the net income by the average outstanding common shares or by dividing the outstanding shares by the total earnings.

·        Shares Outstanding: 100 million

Shares outstanding are the shares in a company that have been authorized, bought, and held by investors. They are also referred to as issued shares or outstanding shares. They represent ownership in the company by the individual that holds them.

·        Market Capitalization: $ 5 billion

The formula for calculating the market capitalization is multiplying the outstanding shares by the current share price. In this instance, the current share price is $50 while the outstanding shares are 100 million. Multiplying the two figures gives us $5 billion.

·        Cost of Capital: 9%

The cost of capital is the opportunity cost of investing in one stock over the option of investing in another stock. It can also be described as the rate of return that the company uses to persuade an investor to invest in a particular stock. When an investor is presented with two choices of investment with equal risk, the investor will usually choose the investment that has the highest return.

·        Growth rate of free cash flows: beyond 2013 3%

Free cash flow is a measure of a company’s financial performance by subtracting the capital expenditures from the operating cash flow. It represents the liquid money that the company is able to generate after removing the money required to maintain the operations in the company.

The growth rate can be calculated by multiplying the retention rate by the return on the invested capital.

·        Efficient market hypothesis and its relationship to stock valuation

Also referred to as the Random Walk Theory, the efficient market hypothesis stipulates that the current stock price reflects the true value of the firm and it is impossible to earn additional profits while using the information. Therefore, it is impossible to beat the market as stock-prices usually react to news/information, which is by definition always random. In other words, stock market efficiency causes the share prices to be a true reflection of the value of the stock incorporating and reflecting all the information pertaining to the stock.

There are three variants to the theory. The weak variant claims that stock prices reflect all the past information that is publicly available. The semi-strong variant proposes that stock prices reflect the publicly available information and they change instantaneously when there is new public information. The third variant, the strong EMH, purports that the stock price reflects even hidden information such as ‘insider’ information or insider trading.  

·        Free cash flow approach to Valuing Stocks

In this scenario, we shall use the free cash flow to equity, which is the cash flow available to common stockholders. The free cash flow to the firms represents all the cash flow that is accessible to the company’s suppliers of capital once all the operating expenses and expenditures have been paid off.

·        Arriving at the intrinsic stock value of $65 for the company

The intrinsic value of a company’s stock can be defined as the current value of the company’s future dividends discounted at the company is cost of equity capital. There are several methods of calculating the intrinsic value of a stock. One popular method of determining the intrinsic value of a stock is the dividend discount model.