3) Is there an imperative for the recommendation? Does the report give me a feeling of security in following the recommendation? -Ask whether the analysis is logically consistent. Are ?good analysis? principles violated? - This is mostly a mathematical one. You need to apply your knowledge from this unit in answering this question. There is no definite answer for this question. You will apply the valuation models to show whether the recommendation is consistent with your understanding/workings.

Equity research reports conclude with a stock recommendation. The investor reads the body of the report to be persuaded that the analysis in the report justifies the recommendation. She asks herself: Is the report credible? Is it internally consistent? Is there an imperative for the recommendation? Does the report give me a feeling of security in following the recommendation? Reports all too often fail to give reassuring answers to these questions. And sometimes they exhibit inconsistencies and fallacies that reveal a lack of craftsmanship in how analysis is done. Below are excerpts from an equity research report on Kmart Corporation, the discount retailer that is a close competitor of Wal-Mart. You might review the firm's web page at www.kmart.com before beginning the case. KMART CORP. March, 1999 (NYSE: KM) Current Price per share: $17 Recommendation: BUY Kmart Corp. is the second largest discount retailer in the United States and the world's third largest general merchandise retailer. It operates department stores in all 50 states in the United States and in Puerto Rico, the U.S. Virgin Islands and Guam. Some pertinent data for 1999 fiscal year ending January 31 are below. 1999 Earnings $518 million Dividends 0 Common equity $5,979 million Debt $2,706 million Cash flow from operations $1,427 million Cash investments $795 million Forecast: We forecast the following earnings and book values per share for fiscal years ending January 31, 2000 and 2001, along with forecasts of P/B ratios and P/E ratios. 1999A 2000E 2001E Eps 1.05 1.23 1.41 Bps 12.12 14.02 15.43 Shares outstanding ($ millions) Price-to-book ratio Price-earnings ratio 493.4 1.40 16.2 493.4 1.36 17.1 493.4 1.38 20.0 We forecast eps to increase at 6% per year after 2001. We also forecast free cash flow to grow at 6% per year from 1999 onwards. Risk: We give Kmart a Beta of 1.15 and a required return of 12% per year. Reco mmendat ion: Our recommendation is based on the ability of the firm to grow its earnings and grow its P/E ratio. By 2001, we expect earnings to be fully flowing from its recent development of Superstores in major metropolitan areas, and see no reason why Kmart's shares should not be trading at a P/E of 20, the current average earnings multiplier for U.S. discount retailers