Question
This assignment focuses on valuation. You will do valuation for a company of your choice (do not choose banks or financial institutions!). You pick one
This assignment focuses on valuation. You will do valuation for a company of your choice (do not choose banks or financial institutions!). You pick one of the options below:
| Grade |
Option 1: Value a stock using multiples | 15 points |
Option 2: Value a stock using discounted CF approach (Dividend or FCF) | 15 points + 2 points extra |
Option 3: Option 1 and Option 2 together | 15 points + 4 points extra |
Option 1: Market-based Valuation
(i) Identify comparables: Look up for the matching companies. You need to identify at least 4 matching companies. You can start by going to https://www.google.com/finance, search for your company, and scroll down to the Related Companies panel for a list of the most related companies.
(ii) Collect information (market price and EPS) to compute P/E ratios for all companies youve picked (main company and its comparables). Financial information can be found from tab Financials on Google Finance or any other financial websites. Present your ratios in a table with a sample form below:
Company Name | Industry | Price | EPS | Book value per share | P/E | P/B | Training P/E | Beta | ROE | Growth |
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Microsoft
| Software | 74.61 | 2.71 | 10.38 | 27.55 | 7.19 | 27.40 | 1.44 | 29.3%
| 42.29% |
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Adobe | Software | 147.94 | 3.18 | 13.10 | 46.54 | 11.39 | 51.44 | .97 | 20.61% | 19.33% |
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General Electric | Technology | 24.57 | .87 | 8.54 | 28.51 | 2.90 | 29.84 | 1.08 | 9.52% | 10.28 |
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SAP | Software | 110.56 | 3.40 | 18.92 | 32.56 | 5.84 | 33.0 | 1.39 | 14.51 | 8.49 |
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Verizon | Telecommunication | 49.45 | 3.90 | 6.18 | 12.68 | 8.00 | 12.81 | .69 | 68.9% | 28% |
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(You can add/delete columns if needed)
Then calculate the average P/E of the matching companies. This average P/E will be your reference P/E. You need to be very clear on the type of P/E (trailing vs leading or both, basic vs diluted EPS used in your calculation,).
Note: If the P/E ratios are negative, you need to switch to other price multiples (P/B, for example).
(iii) Draw conclusion. You need to clearly specify your opinion on the following matters:
(1) Does the company appear to be over- or under-valued relative to its peers?
(2) What should be the companys fair price based on the multiples approach?
(3) Is your conclusion justified? You need to mention the growth potential and/or risks of the company and of the peers.
Option 2: DCF approach
With this approach you need to decide the type of cash flow (dividends or free cash flow) to be used in your valuation, and collect financial information accordingly. You need to estimate growth rate and required returns as well.
(i) Look up for financial information
If you choose dividends, find historical dividend payments.
If you choose FCFF or FCFE approach, find information on the FCFs components (EBIT, NWC,)
(ii) Estimate growth rate
You can compute growth rate using the formula g = b * ROE. Alternatively, you look at past dividends youve collected in the previous step and estimate the growth rate of dividends.
Note that growth rate can change, so try to make reasonable assumptions about how future growth rates will differ from current growth rates.
You can do the same thing with FCFF/FCFE.
(iii) Estimate discount rate
Make reasonable judgments about the market risk premium and the risk-free rate, or find estimates from the Internet. Then estimate the cost of equity by using CAPM.
(iv) Apply the discount model and draw conclusion. You should clearly state the fair price according to your model. It would be useful to compare your target price with the target price reported on other finance outlets as well.
Option 3: If you do both approaches, you can compare the target prices obtained from the two valuation methods and draw overall conclusion.
Let me know if you have any questions!
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