You are a stock analyst specializing in the banking sector. You are constantly trying to identify under (over) priced stocks in order to devise buying (selling) strategies. You have been concentrating your efforts on three stocks: " NAB is the best-performing bank. They have strong local business, and have expanded into foreign markets in recent years (consumer credit cards in particular). Their annual dividend has been growing steadily at a rate of 5% per annum and you cannot see this growth-rate ever changing. Their most recent dividend was $1.20, and the current stock price is $22.00. " CBA has also been a strong performer in recent years. Their most recent annual dividend was $0.90, and you believe this dividend will grow at an impressive rate of 15% per annum for the next three years. After this high-growth period, the dividend growth is likely to stabilize at 4% per annum indefinitely. The current stock price is $25.00. " ANZ has had a rough time lately, but appear to be fighting their way back. Their dividend, however, has been relatively constant at $0.70 per year. Your gut feeling is that, while ANZ should easily maintain their dividend at this level indefinitely, it is unlikely it will increase. The ANZ stock price is currently $10.50.
(a) For each bank, estimate the fundamental stock price using the appropriate dividend discount model. A 10% per annum required rate of return is applicable to all three banks. Assume that all banks pay only one dividend per year, and that the next dividend is due exactly one year from today.
(b) Given your calculations in (a), identify which banks are overpriced (by the market) and which are underpriced.
(c) Having completed your valuation in (a), you start to worry about your assumption of a 10% required rate of return. You are very confident that the market valuation of ANZ ($10.50) is accurate. Similarly, you are adamant that all three banks should have the same discount rate. From the ANZ market price, back out the required rate of return. Using this rate, re-calculate the theoretical value of NAB.?