First choose a publicly traded company that you would hypothetically want to analyze and estimate its price. Please get approval from me so that two students do not estimate the same stock.
Estimation of price using various methods:
1. Method 1: The Dividend Discount Model estimation, You need to perform the followings:
a. If you chose a mature stock: use the Constant Dividend Growth Model (g < k) of chapter 6, (Equation 6-3), find current dividends per share, D(0), from the income statement. Estimate the dividend growth rate, g. You can estimate g in two to three different ways, like historical method, analysts’ estimate, or g = historical ROE* retention rate; then take an average these methods for your final g. Next, estimate the discount rate, k, using the CAPM and D1/P0 +g, and bond yield + premium; then take the average of these three for your final K. Once you have D1, g, and K estimated, then estimate the stock value. Then perform a sensitivity/scenario analysis, see the Valuation of ABC Mature stock file. b. If your stock is a growth stock (g>k), then you need to use two or three stage discounted cash flow model. The estimation of growth stocks are a bit more complicated than mature stocks, an example of two-stage growth is provided in your textbook (An my lecture notes of ch 6). An example of 3 stage growth model is provided in this folder, see the valuation of Growth stock XYZ Excel file.
Note: If your stock is a mature stock, then you do part a above; if your stock is a growth stock you must do part b above. Thus, based on your chosen stock, you either do a or b, you should not do both.
2. Method 2, Residual Income Model: Find or estimate the EPS growth rate. Find book value per share on the balance sheet. Use the discount rate k from part a or b above and estimate the value of your stock according to residual income model of chapter 6. RIM can provide weird estimation. Don’t worry if you get crazy estimate.
3. Method 3: Price Ratio Analysis (Problem 21 of Ch 6)
a. P/E ratio: Find or estimate the EPS growth rate or g. (You can use the same EPS growth rate from part a or b.) Predict next year’s EPS. Then stock price using relative valuation method = Historical P/E * ESP1 (Use the average or historical P/E ratio).
And under interactive charts and advanced chart (Lower indicator) you can plot The P/E ratio. If you chose 10 year chart, you can get approximate average P/E from the lower chart.
I would get the average or historical ratios from Morningstar.com
b. P/CF ratio: Find or estimate the CFPS growth rate. Predict next year’s CFPS. (You can use Cash from Operations on the Cash Flow Statement to approximate operating cash flow.) Then predict stock price using the average P/CF ratio. You could get historical ratios from Morningstar.com. Could also use bigcharts.com
c. P/S ratio: Find or estimate the SPS growth rate. Predict next year’s SPS. Then predict stock price using the average P/S ratio.
4. Now for the fun part! You now have as many as five different estimates for the stock you have chosen. Compare your estimates of stock value to the current actual stock price. Make a prediction about whether the stock is underpriced or overpriced (i.e. whether you should buy it or short it).
5. What you are to turn at the end of semester: Create a neat, organized report of your stock analysis:
a. Section 1: Include your name, the assignment (Term Paper), and a typed concise description of your analysis. Include why you picked the stock, and your conclusions on whether the stock is overvalued or undervalued. Do the results of your calculations agree with other current information that you may know about the company?
b. Section 2: Neat, organized, legible estimations of each model discussed above. Clearly show your five (a or b, c, d, e, and f) stock price valuations and compare it to its market price.
c. Section 3: Conclusion based on your analysis
Note: You can finish writing this paper after we go over chapter 6.