Instructions for Valuation

Part 1 Valuation using Comparables

Returning to your portfolio. For one of the stocks in your portfolio that has a positive P/E ratio and pays dividend (if none of your stocks pay dividend choose another stock), gather the industry and competitors information from www.finance.yahoo.com. This can be done by typing the Ticker of your stock in the "quote lookup" cell and then clicking on industry, and then clicking on industry name on the next page). Yahoo provides industry statistics such as Price / Earnings, Price / Book, Net Profit Margin, Price To Free Cash Flow, Return on Equity, Total Debt / Equity, Dividend Yield. you can use other financial websites to collect this data.

Analyze your stock by answering the following questions (in paragraph form):

1. If your stock was valued at the Industry Average P/E Ratio for these figures, what would be its stock price?

2. If your stock was valued at the Industry average dividend yield, what would be its stock price?

3. What are the P/E ratios for the competitors? Is your stock cheaper or more expensive than the competitors?

Part 2 Value your dividend paying stock using Discount Models

We need to find or compute next period dividend, capitalization rate, and growth rate to be able to use DDM. The following part guides you to find estimates of these parameters.

4. Use the Capital Asset Pricing Model (K = r_f + β ∗ (E(r_m) - r_f)) to determine the appropriate discount rate (capitalization rate) for your stock. Assume that the risk free rate is equal to the rate on 10-year Treasury. Find the 10-year rate here: http://finance.yahoo.com/q?s=^tnx. Assume a market risk premium (MRP) of 12%. You may use the Beta available in the stock's page in www.finance.yahoo.com or other financial websites.

5. Collect data on the most recent "Net Income" and "Total Stockholder Equity" for the company, available in "Income statement" and "Balance sheet", respectively.

You can find this data on the company's page in www.finance.yahoo.com. Use this data to compute growth rate (g). Hint: g = ROE ∗ b, where ROE is the return on equity (net income/share holder equity), and b is the retention or plowback rate. Given that www.finance.yahoo.com has data on earning, price, dividend yield, · · · , you can easily compute b.

6. A second method for computing g is to average the previous growth rates. Since www.finance.yahoo.com only provides income statement for the past three years, we can only compute two growth rates. Compute the average of the growth rates in a relevant parameter (for example "Total Revenue" or "Net Income" from "Income Statement", or "Dividends") for your second proxy of g.

Based on the two g estimates and your own expectation about the future of this company, explain what growth rate do you think this company will experience in future?

7. Now use the Dividend Discount Model (DDM) to value your stock. Note that DDM can only be used if g is less than the capitalization rate. (If this is not the case for any of your g estimates, choose a reasonable estimation, one that is less than the capitalization rate, based on your perception about the future of this company.) How does your estimated price for this company compare to the market price? Explain the assumptions you used and whether you find them reasonable. How do changes in the capitalization rate (k) and/or growth rate change your analysis?

8. Based on your analyses using comparables and DDM, and your own opinion about the future of this company, what is your buy/sell/hold recommendation?