Zowie is a six-year-old company that specializes in immediate (less than two hours) delivery of computer peripheral devices to consumers. The value-added in the service comes not only from the speed of delivery, but the delivery person’s ability to install and troubleshoot the new device on any computer. Zowie’s! earnings have grown at a rate of 35% per year, to a (just-announced) value this year of $2,000,000, or $2 per share.
Recently, Zowie! has experienced a slowdown in earnings, due to the fact that the supply of delivery people with a deep knowledge of computers is growing scarcer. Zowie! does not anticipate that this situation will improve anytime soon; consequently, analysts have forecast that earnings for the next 3 years will grow at a slower rate. After that three-year period, it is forecast that the company will be mature and grow at a ‘stable’ rate per year for the foreseeable future.
Assume that the company does not begin paying dividends until the year that the growth rate stabilizes (year 4), at which point dividend payout will be two-thirds of earnings. Zowie! does not have debt currently, and has no plans to issue debt or equity. An appropriate discount rate for cash flows of Zowie’s! risk is 14% per year
The growth rate estimates for the next three years range from a low of 10% per year to a high of 15% per year. The estimates for the mature or ‘stable’ rate per year after that time ranges from a low of 3% per year to a high of 5% per year.
a) Based on this information, calculate a minimum or low value for a share of Zowie! stock today. (Hint: begin by calculating Zowie!’s earnings over the next few years, then calculating Zowie!’s dividends over the next few years.)
b) Based on this information, calculate a maximum or high value for a share of Zowie! stock today. (See hint above.)
c) Assume that the 15% growth rate over the next three years is accurate. You observe that the current price of a share of Zowie! stock is 50% larger than the price you calculated in part b). Calculate the ‘stable’ growth rate implied by this share price, assuming that the market shares your belief about the appropriate discount rate.
d) Examining the prices in a) and b), would you characterize Zowie! as a ‘growth’ stock? State any assumptions you make, and explain your answer.