In this chapter, we described the various factors that influence stock prices and the approaches that analysts use to estimate a stock’s intrinsic value. By comparing these intrinsic value estimates to the current price, an investor can assess whether it makes sense to buy or sell a particular stock. Stocks trading at a price far below their estimated intrinsic values may be good candidates for purchase, whereas stocks trading at prices far in excess of their intrinsic value may be good stocks to avoid or sell. Although estimating a stock’s intrinsic value is a complex exercise that requires reliable data and good judgment, we can use the Internet to find financial data in order to arrive at a quick “back-of-theenvelope” calculation of intrinsic value.

Questions

1. For purposes of this exercise, let’s take a closer look at the stock of ExxonMobil Corporation (XOM). Use websites such as Yahoo! Finance, Google Finance, MSN Money (msn.com/en-us/money/markets), and Morningstar to find the company’s current stock price and see its performance relative to the overall market in recent months. What is ExxonMobil’s current stock price? How has the stock performed relative to the market over the past few months?
2. Check recent headlines on the website to see the company’s recent news stories. Have there been any recent events impacting the company’s stock price, or have things been relatively quiet?
3. To provide a starting point for gauging a company’s relative valuation, analysts often look at a company’s price-to-earnings (P/E) ratio. Go to the website’s summary quote or key statistics screen to see XOM’s forward P/E ratio, which uses XOM’s next 12-month estimate of earnings in the calculation, and to see its current P/E ratio. What are the firm’s forward and current P/E ratios?
4. To put XOM’s P/E ratio in perspective, it is useful to see how this ratio has varied over time. (If you go to Morningstar and click on the valuation tab, you should see a 10-year summary of its P/E ratio.
In addition, it shows ExxonMobil’s 5-year average.) Is XOM’s current P/E ratio well above or well below its 5-year average? Explain why the current P/E deviates from its historical trend. On the basis of this information, does XOM’s current P/E suggest that the stock is undervalued or overvalued?
Explain.
5. In the text, we discussed using the discounted dividend model to estimate a stock’s intrinsic value. To keep things as simple as possible, let’s assume at first that XOM’s dividend is expected to grow at a constant rate of 4% annually over time. So, g = 4%. If so, the intrinsic value equals D₁/(r_s - g), where D₁ is the expected annual dividend 1 year from now, rs is the stock’s required rate of return, and g is the dividend’s constant growth rate. Go back to the statistics screen and find XOM’s current (trailing) annual dividend.
Multiply this dividend by 1 + g to arrive at an estimate of D₁.
6. The required return on equity, r_s, is the final input needed to estimate intrinsic value. For our purposes, you can assume a number (say, 9% or 10%) or you can use the CAPM to calculate an estimate of the cost of equity, using the data available on the Internet. (For more details, look at the Taking a Closer Look exercise for Chapter 8.) Having decided on your best estimates for D₁, r_s, and g, you can calculate XOM’s intrinsic value. Be careful to make sure that the long-run growth rate is less than the required rate of return. How does this estimate compare with the current stock price? Does your preliminary analysis suggest that XOM is undervalued or overvalued? Explain.

7. It is often useful to perform a sensitivity analysis, where you show how your estimate of intrinsic value varies according to different estimates of D₁, r_s, and g. To do so, recalculate your intrinsic value estimate for a range of different estimates for each of these key inputs. One convenient way to do this is to set up a simple data table in Excel. On the basis of this analysis, what inputs justify the current stock price?
8. Until now, we have assumed that XOM’s dividend will grow at a long-run constant rate of 4%. To gauge whether this is a reasonable assumption, it’s helpful to look at XOM’s dividend history. If you go to the MSN Money website (msn.com/en-us/money/markets) and go to the annual income statement on the financials screen, you should see the firm’s annual dividend over the past 4 years. On the basis of this information, what has been the average annual dividend growth rate?
On the basis of the dividend history and your assessment of XOM’s future dividend payout policies, do you think it is reasonable to assume that the constant growth model is a good proxy for intrinsic value? If not, how would you use the available data on the Internet to estimate intrinsic value using the non constant growth model?
9. Finally, you can also use the information on the Internet to value the entire corporation. This approach requires that you estimate XOM’s annual free cash flows. Once you estimate the value of the firm’s operations and the value of any nonoperating assets, you subtract the value of debt and preferred stock to arrive at an estimate of the company’s equity value. By dividing this value by the number of shares of common stock outstanding, you calculate an alternative estimate of the stock’s intrinsic value. Although this approach may take additional time and involves more judgment concerning forecasts of future free cash flows, you can use the financial statements and growth forecasts on the Internet as useful starting points. If you go to the annual cash flow statement on the financials screen, you will find historical annual free cash flow values. These numbers are useful as a starting point to arrive at an estimate for the next year. Note that you can also obtain historical free cash flows over a 4-year period from Morningstar. After entering the company’s ticker symbol, simply select the Financials tab, and scroll down to Cash Flow.