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five-year growth rate of IBM

Go to Yahoo! Finance at http://finance.yahoo.com/ and look up the stock information for a publicly traded company of your choosing. If you already know your publicly traded company's stock symbol, all you have to do is enter the letters in the "Get Quotes" field near the top of the page and then press the "Go" button. If you have a company in mind but don't know its symbol, simply click the "Symbol Lookup" link next to the "Go" button. Type the name of the company you want to find in the "Name" field on the Symbol Lookup page and then click the "Look Up" button. Once you find your company's stock information, you may complete the Dropbox Project below. In order to arrive at a value for the stock, you will gather and use information from Yahoo! Finance (http://finance.yahoo.com).

You will apply the concepts of risk and return by estimating the stock's required return from the CAPM model to arrive at the firm's cost of equity. Once the firm's cost of equity has been estimated, you will use the dividend growth model's constant growth assumptions to value the firm's stock. In addition, you will also use the non-constant growth model to value the stock. You will then compare your calculated stock price (using the preferred methodology) to the firm's traded stock price, and then explain, as an analyst would, whether an investor should purchase, sell, or hold the stock.

Project

Please answer the following the questions about the company you chose.

Estimate your firm's expected five-year growth rate by dividing the PEG ratio by the forward looking P/E ratio.
(Hint: Click the "Key Statistics" link in the left navigation bar. The PEG ratio and forward looking P/E ratio for your firm will be listed in the "Valuation Measures" area of the Key Statistics page.)
Using the expected 5-year growth rate, what is your firm's next expected annual dividend, D1?
(Hint: D0 is given on the Quotes screen.)
Assume that your firm's dividend will grow at a constant rate equal to the expected five-year growth rate. Using the DCF model, what is the firm's stock price? Does it seem like a reasonable estimate?
Now, let's try to use the non-constant growth method to value this stock. The long-run constant growth rate of most stocks is expected to be between 3% and 8%. Instead of assuming constant growth starting today, use the five-year growth rate to estimate dividends for the next five years and then assume a long-run constant growth rate between 3% and 8%.
Select a number that makes sense for the industry in which your company operates. What is the firm's intrinsic value now?
Consider the estimates from both methodologies. Which methodology is more useful in valuing your company? Offer some explanations for your answer.
Now, assume you are an analyst. On the basis of the price estimate calculated using your preferred methodology, would you recommend investors to purchase, sell, or hold the stock. Explain your answer.

Solution Preview

Estimate your firm's expected five-year growth rate by dividing the PEG ratio by the forward looking P/E ratio.

(Hint: Click the "Key Statistics" link in the left navigation bar. The PEG ratio and forward looking P/E ratio for your firm will be listed in the "Valuation Measures" area of the Key Statistics page.)

I will show you how to do this for IBM. It isn't that difficult, so with this example, you should be able to do other stocks. Make sure that it is a mature, stable corporation. The discounted cash-flow valuation assumes relatively constant growth for the long term, which isn't appropriate for firms that are relatively new.

Expected five-year growth rate: 1.31/12.28=0.107

Using the expected 5-year growth rate, what is your firm's next expected annual dividend, D1?
(Hint: D0 is given on the Quotes screen.)

First, we use earnings per share from the quote page: 7.18
Now we multiply this by the value obtained in part 1:
7.18 x 0.107 = 0.77
Therefore D2 will be 7.18 + .77 =7.95

Assume that your firm's dividend will grow at a constant rate equal to the expected five-year growth rate. Using the DCF ...

$2.19