Stock Analysis Assignment (Fin 475)
Follow the below format & instructions for your stock analysis. You grade will be based on completing the below instructions in a coherent (well written) and convincing (well argued) way. You must show your work on your calculations. You must choose a company to analyze for which you can obtain the below listed information. (Hence, it may be necessary for you to select a mid or large cap stock as it may be difficult to acquire the requisite information for very small companies.)
Your assignment must be organized with a numbering system referring to each one of the below listed numbers/sections.
Your stock analysis is meant to be similar to a stock report from an investment brokerage house. Hence, it does not need to recommend a “buy” of the stock – as many brokerage houses cover stocks on which they may not currently have a “buy” recommendation. There are numerous websites that you will use to obtain stock information – make sure to cite them, particularly when a graph, table, or data is/are taken directly from the website.
The vast majority of the links referenced below can be obtained from the One Approach To Gathering Information About Stocks (heretofore, “One Approach”) which is linked to from my Econ 475 Canvas website. There also links referenced below to General Investing Resources which is also linked to from my Econ 475 Canvas website.
Quick Summary (Put this at the front of your assignment.)
You should probably do this last since many of the numbers will be included in the above steps of your stock analysis.
State you Investment Recommendation: Buy, Sell, or Hold.
Create a small table with Earnings Per Share (EPS) for the past 5 years and the analyst estimates for earnings in the current year and following year.
Use either basic or diluted EPS, but state which one you are using if it is given from your source.
See #10 from “One Approach” for the analyst estimates.
EPS data will be included in the income statement.
Create a small table with Profitability Metrics: ROA, ROE, Net Profit Margin (Net Income / Sales), and Operating Margin (Operating Income / Sales) for the last complete fiscal year (i.e., the last year where annual figures are reported).
Margins can be calculated from the income statement.
Create a small table with Valuation Metrics: Total Assets, Market Cap, Price / Book Value Per Share, P/E ratio (ttm, i.e., trailing/past twelve months of earnings), PEG Ratio.
Assets will be reported on the balance sheet.
1) Company profile
You should describe the company and its businesses/products.
See, for example, #2 and #3 from “One Approach.”
2) Industry competitors
You should give a list of the company’s competitors. Use your judgment in including companies from your reference websites.
See, for example, #4 from “One Approach.”
3) Market position, growth opportunities, and risks (This is the heart of your analysis.)
From the information you can obtain, you should try to describe as accurately as possible the company’s approximate market share in each of its major businesses (if you can find the data), and the company’s approximate market share in its primary products (if you can find that data). You should also try to explain why you believe that the company will maintain, increase, or decrease its market share. You should also explain the key risks for the company – that is, the key factors which can influence the financial success or lack of success for the company moving forward. Include a discussion of the firm’s ROE and its ability to maintain or increase that ROE moving forward.
Include a discussion of the size of the company’s moat and the likelihood the moat will change over time. (For a reminder on moats see “Buffett on Moats and Share of Mind” from “General Investing Resources” which is linked to above.)
Include a discussion of what you believe will happen to the company’s sales and operating margin over time. Also explain why.
See, for example, #3, #5, and #6 from “One Approach.”
4) Valuation (This is the soul of your analysis.)
For parts b, c, and d, show your work whenever using valuation formulas (for example, when using either of the one stage models or when calculating a terminal value in a two stage model).
4-a) You should report valuation ratios compared to the industry and S & P 500.
See, for example, #9 (the “Morningstar 2” link) from “One Approach.”
Report the data in the “Current Valuation” table at the “Morningstar 2” link.
Comment in particular on the price to earnings and the price to book ratios.
Calculate the average net income/earnings growth over the last 5 years (links to income statements are referenced in the discussion of financial statements below) and construct the PEG ratio.
Does the company seem overvalued or undervalued based on the PEG ratio?
Explain.
4-b) If the company pays dividends, use the dividend discount model (DDM) to value the company.
Note: If the dividends for your company are zero then skip 4-b and go straight to 4-c.
Use either the constant growth DDM or a two-stage (or multi-stage) DDM. (See chapter 13.)
If you use a constant growth DDM use the following equation to value the company: D_{0}(1 + g)/(k – g), where D_{0} is the current dividend level.
Note: g must be less than k.
Your choice of g should be driven by your discussion in Step 3 above.
You should not use the equation g = ROE x b or the current / recent-past growth rate unless you have a very good argument as to why, as these typically will yield a long run / terminal growth rate which is too high.
See “Calculating k” which is in bold below to see how to calculate k.
If you use a two-stage DDM, forecast out dividends for 5 years (or more if you want). Then assume a fixed growth rate in dividends from the 5^{th} year forward to calculate a terminal value in the 5^{th} year. Then find the present value of (i.e., discount) the dividends for each of the five years and the terminal value for the fifth year. Then take the sum of the discounted values to determine your final valuation using the DDM model.
To find the present value of (i.e., to discount) each year’s dividends, divide each year’s dividends by (1 + k)^{t}, where t is the number of years forward. Use the below listed equation in red to calculate the discount rate, k.
To calculate the terminal value use the equation D_{0}(1 + g)/(k – g), where D_{0} is the dividend in year 5. Remember to discount the terminal value by dividing by (1 + k)^{t} before taking the sum of the discounted values.
Note: g must be less than k.
Your estimated dividends and your choice of g should be driven by your discussion in Step 3 above.
Explain your choice of DDM (e.g., why you used the constant growth model as opposed to the two stage model).
4-c) Use “Owner-Earnings,” a variation on FCFE, to value the company.
Owner-Earnings (OE) = Net Income (excluding any unusual income/charges) + Depreciation & Amortization – Capital Expenditures.
If you want to get a little more sophisticated, you can use “maintenance capex” in place of Capital Expenditures in the above equation. Maintenance capex is the amount of capital expenditures necessary for the firm to maintain the current level of competitiveness/profitability. See “Calculating Warren Buffett’s Maintenance Capex” from “General Investing Resources” which is linked to above.
Use either a constant growth owner-earnings discount model or a two-stage (or multi-stage) owner-earnings discount model. (See equation 13.12, and substitute owner-earnings for FCFE.)
Note: If you calculate owner-earnings and it is negative then you must use a two-stage or multi-stage owner-earnings model.
If you use a constant growth owner-earnings discount model, use the following equation to value the company: OE_{0}(1 + g)/(k – g), where OE_{0} is the current level of owner earnings.
Note: g must be less than k.
Your choice of g should be driven by your discussion in Step 3 above.
You should not use the equation g = ROE x b or the current / recent-past growth rate unless you have a very good argument as to why, as these typically will yield a long run / terminal growth rate which is too high.
See “Calculating k” below to see how to calculate k.
You must divide your final number for the value of the company by the number of shares outstanding to get a per-share value of the company.
If you use a two-stage owner-earnings model, forecast out earnings for 5 years (or more if you want). Then assume a fixed growth rate in owner-earnings from the 5^{th} year forward to calculate a terminal value in the 5^{th} year. Then take the present value of (i.e., discount) the owner-earnings for each of the five years and the terminal value for the fifth year. Then take the sum of the discounted values to determine your final valuation of the company using the owner-earnings discount model. To get a per-share value of the company, you must then divide by the number of shares outstanding. This information is typically found in the income statement of a company.
Note: If you calculate owner-earnings and it is negative, you must forecast out owner earnings until it is positive. You cannot calculate a terminal value unless the owner-earnings for the period in which you are calculating a terminal value is positive. Therefore, if you are forecasting out earnings for 5 years, make sure that your forecasted owner-earnings for the 5^{th} year is positive.
To find the present value of (i.e., to discount) each year’s owner-earnings, divide each year’s owner-earnings by (1 + k)^{t}, where t is the number of years forward.
See “Calculating k” below to see how to calculate k.
To calculate the terminal value use the equation OE_{0}(1 + g)/(k – g), where OE_{0} is the owner-earnings in year 5. Remember to discount the terminal value by dividing by (1 + k)^{t} before taking the sum of the discounted values.
Note: g must be less than k.
See “Calculating k” below to see how to calculate k.
See the immediately above underlined note if owner-earnings in your last year is negative.
Your estimated owner earnings and your choice of g should be driven by your discussion in Step 3 above.
You must divide your final number for the value of the firm by the number of shares outstanding to get a per-share value of the company.
Explain your choice of owner-earnings model (e.g., why you used the constant growth model as opposed to the two stage model).
4c) Calculating k
Use the following equation to calculate k: r_{f} + β[E(r_{M}) – r_{f}]
r_{f} is the risk-free rate of return. Use the return on the 10-year treasury note – approximately 2.0%.
β (beta) can be found on Yahoo! Finance. Enter the ticker, select “key statistics,” and you will see beta on the right side of the page under “Trading Information.”
E(r_{M}) is the expected return on the market portfolio. Use the historical S&P 500 return – approximately 8.5%.
4d) Discuss your rationale for your choice of g in the above models.
5) Ratio analysis
You should report profitability and financial health ratios.
See, for example, #9 (the “Morningstar 1” link).
For profitability ratios, click on “Profitability” below “Key Ratios” and then report the ratios under “Profitability” for the past 10 years.
For financial health ratios, click on “financial Health” below “Key Ratios” and then report the ratios under “Liquidity/Financial Health” for the past 10 years.
Briefly describe the trends in these ratios and what you feel the importance is.
6) Institutional ownership and changes
You should report the level of institutional ownership and changes in institutional ownership over the last quarter.
See, for example, #12 (Institutional Ownership – Total) from “One Approach.”
You should also describe what you feel is the importance of the numbers.
7) Insider transactions
You should report the purchases of stock by executives in the corporation.
See, for example, #13 (the “Morningstar” link) from “One Approach.”
Under “Weekly Insider Transactions” select “2 Year,” “Buy,” and “All Transactions.”
Briefly describe what you feel is the importance of the numbers.
8) Analyst recommendations and changes
You should report analyst ratings and changes in analyst ratings.
See the second and third link under #11 from “One Approach.”
Report current recommendations and recommendations in each of the last 3 months.
Also report a graph of broker recommendations and price against time. Make sure to cite your source.
Briefly describe what you feel is the importance of the numbers.
9) 5 year chart
Present an approximate 5 year chart (or weekly chart) from your favorite charting website. One possible source is StockCharts.com. Make sure to cite your source.
10) Recommendation (This is your conclusion.)
Bring together all of the preceding parts of the analysis to make a conclusion. Discuss the pros and cons of the company (stock). Make a final recommendation on the stock (Buy, Sell, Neutral) based on your analysis.
11) Appendix: Financial Statements
Report the following financial statements for your company for the last 5 years.
You can export the financial statements (income statement, balance sheet, cash flow statement) from the “Financial Statements” link under #9 from “One Approach.”
When you export the data, save it rather than just trying to open it. After you have saved the file, then go to the folder where the file is saved and double click on it to open it.
Enter the symbol in the box next to where it says "Quote" at the top and press enter. Click on "Income Statement," "Balance Sheet," or "Cash Flow" under the company name.
All other information should be put into the text of your stock analysis. Do not put sections above into the appendix.
Subject | Business |
Due By (Pacific Time) | 07/29/2015 12:00 am |
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