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Question:
Discuss about the Managerial Finance for Micro Level Equity Valuation.

 
Answer:
Introduction

The most theoretically sound method of valuation of the stock is called discounted cash flow method or income method. It involves discounting of the dividends earnings or cash flows. On the micro level equity valuation is beneficial for the stock ecosystem. Well markets receive information and make a move to factorize the financial essence. Individual methods may vary the stock price and therefore, the price of the shares can fluctuate accordingly. Henceforth, there can be a variance between the market value and the intrinsic value of the company. In opinion of the second richest person in the world, Warren Buffett has turned his fortune through the art of equity valuation. In fact, the theory of equity valuation has been heavily influenced by the work of Warren Buffett.

 

Computation of the Cost of equity of company by using the CAPM method

CAPM Method

 

RF

Risk free rate of return

RM

Market premium

Beta

risk of the Company

Cost of equity

RF+(RM-Rf)B

 

PARTICULARS

PRICE OF SHARES

RISK FREE RATE OF RETURN

BETA

MARKET RATE

 

 

 

 

 

INFORMATION TECHNOLOGY

 

 

 

 

COMPUTERSHARE LIMITED

17.57

2.77%

1.04

12.2%

WISETECH GLOBAL

13.25

2.77%

2.39

12.2%

DOMAINHOLDINGS AUSTRALIA

33.55

2.77%

0.82

12.2%

 

 

 

 

 

ENERGY

 

 

 

 

ORIGIN ENERGY LIMITED

9.93

2.77%

1.2915

12.2%

CALTEX AUSTRALIA LIMITED

30.5

2.77%

0.91

12.2%

WORLEYPARSONS LIMITED

17.44

2.77%

1.69

12.2%

NEW HOPE CORPORATOIN LIMITED

2.43

2.77%

4.82

12.2%

 

 

 

 

 

FINANACIALS

 

 

 

 

COMMON WEALTH BANK OF AUSTRALIA

70.94

2.77%

1.01

12.2%

STEADFAST GROUP LIMITED

25.8

2.77%

1.18

12.2%

SUNCORP GROUP LIMITED

13.93

2.77%

0.89

12.2%

 

Computation of the share price of these different companies by using the Dividend growth rate model

Price of the company

D1/ Ke-G

 

 

D1

Expected Dividend for the year

 

 

D0

The most recent cash dividends

 

 

Re

Required rate of return

 

 

G=

Expected Annual Growth rate

 

 

 

 

 

 

 

 

 

 

Computation of the Dividend Growth rate of Company

 

 

Growth rate

(1-Dividend pay-out ratio)*Rate of Equity

 

 

 

PARTICULARS

Cash dividend

Earnings

Earnings

Dividend Pay-out Ratio

Return On Equity

Return on Equity

Growth Rate

 

 

 

 

 

 

 

 

INFORMATION TECHNOLOGY

 

 

 

 

 

 

 

COMPUTERSHARE LIMITED

139

2720

2.16%

5%

12370

22%

21%

WISETECH GLOBAL

102

1537

0.17%

7%

3500

44%

41%

DOMAINHOLDINGS AUSTRALIA

40

63.31

0%

63%

580

11%

4%

 

 

 

 

 

 

 

 

ENERGY

 

 

 

 

 

 

 

ORIGIN ENERGY LIMITED

100

6429

0.00%

2%

17590

37%

36%

CALTEX AUSTRALIA LIMITED

61

2435

4.05%

3%

2610

93%

91%

WORLEYPARSONS LIMITED

100

5200

1%

2%

27300

19%

19%

NEW HOPE CORPORATOIN LIMITED

6

-235

4.98%

-3%

831

-28%

-29%

 

 

 

 

 

 

 

 

FINANACIALS

 

 

 

 

 

 

 

COMMON WEALTH BANK OF AUSTRALIA

390

9928

6.06%

4%

17600

56%

54%

STEADFAST GROUP LIMITED

280

4975

2.49%

6%

7930

63%

59%

SUNCORP GROUP LIMITED

33

1075

5.23%

3%

1299

83%

80%

 

PARTICULARS

D1=D0(1+G)

Required Rate of Return= Rf+B(Rm-Rf)

Rate of Growth Dividends= (1-d/e)*ROE

D1/Re-G

 

 

 

 

 

 

 

INFORMATION TECHNOLOGY

 

 

 

 

 

COMPUTERSHARE LIMITED

168

13%

21%

1335.56

 

WISETECH GLOBAL

144

25%

41%

567.88

 

DOMAINHOLDINGS AUSTRALIA

42

11%

4%

396.12

 

 

 

 

 

 

 

ENERGY

 

 

 

 

 

ORIGIN ENERGY LIMITED

136

15%

36%

909.28

 

CALTEX AUSTRALIA LIMITED

116

11%

91%

1025.27

 

WORLEYPARSONS LIMITED

119

19%

19%

634.25

 

NEW HOPE CORPORATOIN LIMITED

4

48%

-29%

9.12

 

 

 

 

 

 

 

FINANACIALS

 

 

 

 

 

COMMON WEALTH BANK OF AUSTRALIA

601

12%

54%

4890.78

 

STEADFAST GROUP LIMITED

446

14%

59%

3207.03

 

SUNCORP GROUP LIMITED

59

11%

80%

531.96

 

 

 

 

 

 

 

COMPARABLE APPROACH

 

PARTICULARS

MPS

EPS

PE ratio (MPS/EPS)

SHARE VALUE

Rank

 

 

 

 

 

 

INFORMATION TECHNOLOGY

 

 

 

 

 

COMPUTERSHARE LIMITED

17.57

0.57

30.82

17.57

3

WISETECH GLOBAL

13.25

0.57

23.25

13.25

6

DOMAINHOLDINGS AUSTRALIA

33.55

0.35

95.86

33.55

8

 

 

 

 

 

 

ENERGY

 

 

 

 

 

ORIGIN ENERGY LIMITED

9.93

1.2

8.28

9.93

7

CALTEX AUSTRALIA LIMITED

30.5

1.4

21.79

30.5

2

WORLEYPARSONS LIMITED

17.44

1.3

13.42

17.44

4

NEW HOPE CORPORATOIN LIMITED

2.43

0

#DIV/0!

#DIV/0!

10

 

 

 

 

 

 

FINANACIALS

 

 

 

 

 

COMMON WEALTH BANK OF AUSTRALIA

70.94

2.2

32.25

70.94

1

STEADFAST GROUP LIMITED

25.8

1.5

17.20

25.8

9

SUNCORP GROUP LIMITED

13.93

0.57

24.44

13.93

5

 

The ten investments are ranked in order of desirability taking a factor into consideration namely risk per unit of return factor. This formula is applied to determine the rank of the company on the basis of Beta/ Cost of Equity. From the above calculations it can be analysed that SunCorp Group Limited is ranked as number 1 on the basis of risk per unit of return is 0.1357 which is the least as compared to other companies and sectors. However it will also depend upon the choice of the investor. Therefore, the ranks have been given according to the value of the beta (Owens, 2018).

The risk at times plays a pivotal role in determining the choice of shares the investor is going to invest. At times the investors like to invest in the risky shares and times totally opposite approach are followed. If higher returns are what an investor is looking for than the investor can opt for either Wisetech Global or WorleyParsons Limited. Buying these two categories of shares; on belonging to the information technology sector and other being an energy share will definitely ensure more returns along with risk. Therefore, the selection of shares will always depend upon the type of the company.

In the Information Technology sector there are three companies which are

  • Computershare Limited
  • Wisetech Global
  • Domainholdings Australia

Warren buffet is a Business investor who is currently based in America. He is serving as a CEO of Berkshire Hathaway. In one of the recent articles in the magazines Warren Buffet descriptively showcased his choice of shares. The WiseTech Global Ltd continued its strong run and reached at a new level of $13.05. The year to date return rousted to a staggering 130%. The shares jumped off higher in opinion of Warren Buffet because of the acquisition of leading warehouse management space worth $41million. The costing was around $20 million upfront with a multi-year revenue-out potential of an additional $20 million. The additional money was utilised for integration of the product and to have a futuristic growth of 22% by financial year 2020. After the release, Microlistics delivered overall revenue of $6.72 million and EBITDA ended up at $1.6 million. This kind of share can be opted for if dividend is the second priority of the investor (Owens, 2018).

The next company of Domain holdings Australia the revenue grew by 12.5% and reached till $183 million. Side by side, the EBITDA also grew by8.7% and ended up at %56.8 million. Though this share is ranked ta number 8 in terms of Beta value yet in term of equity it has a lot of scope. An interim dividend of 4 % was also distributed to the shareholders (Owens, 2018).

Similarly in energy sectors there are shares which are as follows.

  • Origin Energy Limited
  • Caltex Australia Limited
  • Worleyparsons Limited
  • New Hope Corporation Limited

Taking into consideration the energy sector shares, the shares of Origin Energy Limited failed to invest in the renewable energy sufficiently. Origin Energy Limited (Origin) announced a Statutory Loss of $1.69 billion, due to an impairment charge of $1.8 billion. This covers 37.5 per cent share of Australia Pacific LNG’s impairment of Origin Energy Limited. The EBITDA increased to $277 million and by 32 per cent to $1.15 billion, giving the view of solid operational performance of the business. The profit of the company reduced by 28% and ended up at 184 million (Infront Analytics, 2017). Therefore, dividend was not declared (Akansu, 2017).

In opinion of Warren Buffet Caltex Australia Limited is one of the classic shares. The company generated revenue of $112 million in the current financial year. The company reported a 33.3% rise in EBIT and a 25% increase in the revenue as compared to previous years. The dividend yield crossed the rate of 4.05% (Akansu, 2017). According to Warren Buffet, the Caltex Australia Limited is currently trading more than its fair value by 2.11 % (ASX,  2018).

Lastly the shares of the Financial Sector in which the portfolio involves the shares which are as follows

  • Common Wealth Bank of Australia
  • Steadfast Group Limited
  • Suncorp Group Limited

In Warren Buffet’s opinion the price of Commonwealth Bank of Australia can shoot up over the next upcoming years. The design or the structure of the Commonwealth Bank of Australia is significantly popular and currently captures a market share worth 22%. A fully ranked interim dividend of $2 was distributed among the shareholders which shows a 100% increase as compared to previous years. This represents a dividend pay-out ratio of 72% of cash NPAT. The forecast made by the management involves an increase in revenue by US$60 million from the current year to the financial year 2020 (Owens, 2018). This means that the trades are made at discount to the intrinsic value of share by this company. The revenue is expected to grow from $3.20 billion to $4.60 billion in 2019 (Owens, 2018).

 The SunCorp Group Limited is considered as a high growth stock and the investors are ready to buy the stock at $13.93. This share is of utmost potentials (Akansu, 17). In opinion of Warren Buffet, going through the current revenue the revenue grew by $27 million as compared to the previous years. The overall profit resulted in $1075 million. The ordinary dividends were fully franked by 73%. The EBITDA also grew by 8.7% reaching at $46.8 million. The results were positive and the print segment was enhanced qualitatively. This kind of volatility showcases greater risks for the investors who are investing in the stock market passively. In opinion of Warren Buffet Suncorp Group can help in revamping the portfolio (Ahmadi, 2017).

According to Warren Buffet approach the share valuation can be done as follows. In Buffet’s opinion, he is not considered about the intricacies of the demand and supply factors prevailing in the market. In fact the stocks are chosen by him on the basis of the overall potential as a company. The following factors are considered before taking the overall decision. The questions are as follows;

 
Has the company consistently performed well in terms of return on equity?

It is calculated on the basis of a formula Net Income/ Shareholder’s Equity. According to Warren Buffet the investor shall g through the historical performance of past 4 to 10 years in terms of ROE (Chateau, 2017).

Has the company avoided the excessive debt?

The ratio of Debt/Equity is one of the factors taken into consideration by Buffet. A small amount of debt is preferred by Warren Buffet so that the revenue can be generated from shareholder’s equity in contrast to the borrowed money. The following formula is used to calculate the ratio. Total Liabilities/ Shareholder’s Equity.  A lower level of Equity eventually is clubbed with volatile earnings and huge amount of expenses
(Harris, Nassios & Giesecke, 2017). 

Are profit margins high? Whether they are increasing?

A good profit margin is not sufficient rather than an increasing margin is required. This margin is calculated as Net Income/Net Sales. A sound profit margin will indicate the performance of the company and how efficiently they are working on controlling expenses (Paul, 2018)

How long the company has been public?

Buffet typically considers only those shares of the company which are into existence since past 10 years. Only those business shall be executed in which there is a proper description and understanding. Therefore, it can be analysed from the above research that Buffet adopts the valuation exercises and attempts to determine the return on investment, growth rate of book value, earnings per share, Price earnings ratio, revenue, net income, future stock price. All these intricacies will eventually help in determining which share to purchase and when (Akansu, 2017). 

Share valuation Methodology

Warren Buffet’s Two-column Valuation Methodology deals with the Market price and intrinsic value. The one more element that can be added to this valuation methodology is the efficacy of retaining the earnings for future purposes. The methods that are used for valuation of shares are Relative valuation model, Dividend Discount Model, Discounted Cash flow model.

  • Relative Valuation Model:

This model is utilised when there is a need to compare the companies working in the similar industry. Under this method the main component is calculation of P/E Ratio (Minifie, 2017).  For example if the P/E ratio of the company is lower that company is considered as undervalued. This method is easy to calculate and understand; therefore this method is adopted by most of the investors for calculation of share valuation.

  • Dividend Discount Model

This model helps in deriving the true picture and worth of the firm on the basis of the dividends that are paid to the shareholders of the company. Under this model, the first there exists two phases. The first phase deals with the calculation of the dividend. The second phase deals with the determination of the fact whether the dividend is stable and predictable (Allen & Rachim, 2016).

  • Discounted Cash Flow Model

This model is associated with situations where there is a possibility of irregular dividends or no dividends. The greatest advantage of this model is utilised by the firms who do not pay out the dividends.

Conclusion

Therefore, from the above analysis it can be concluded that the approach that can be preferred will depend upon the type of the industry and the prevailing company. Also it depends upon the investors, what kind of valuation option they are choosing.  Often investors like to involve in number of calculations and options to create a wide range of possibilities and alternatives. At times it happens a single valuation is not sufficient to decide which share should be bought therefore; one single approach cannot be a solid criterion to decide the valuation (Owens, 2018).

 
References

Ahmadi, A. (2017). The Stock Price Valuation of Earnings per Share and Book Value: Evidence from Tunisian Firms. The Journal of Internet Banking and Commerce, 22(1), 1-11.

Akansu, A. N. (2017). The flash crash: a review. Journal of Capital Markets Studies, 1(1), 89-100.

Allen, D. E., & Rachim, V. S. (2016). Dividend policy and stock price volatility: Australian evidence. Applied financial economics, 6(2), 175-188.

ASX. (2018). Company Information. Retrieved from https://www.asx.com.au/prices/company-information.htm

ASX. (2018). The Official List (Listed Companies) Retrieved from https://www.asx.com.au/asx/research/listedCompanies.do

Chateau, J. P. (2017). Fundamental analysis: Stock valuation. New York: Springer.

Harris, J. N., Nassios, J., & Giesecke, J. (2017). Determining agent-specific rates of return in a Financial CGE model of Australia. Victoria University: Centre of Policy Studies

Infront Analytics. (2017). Infront Analytics Infromaiton. Retrieved from: https://www.infrontanalytics.com/fe-en/32713AA/SUNCORP-GROUP/beta

Kraft, H., Schwartz, E., & Weiss, F. (2018). Growth options and firm valuation. European Financial Management, 24(2), 209-238.

Minifie, J. (2017). Competition in Australia. New York: Springer.

Owens, D. (2018). Simply Wall ST. Retrieved from https://simplywall.st/stocks/au/banks/asx-ben/bendigo-and-adelaide-bank-shares/news/what-makes-bendigo-and-adelaide-bank-limited-asxben-a-great-dividend-stock/

Paul, E. (2018). Australia in the US Empire: A Study in Political Realism. New York: Springer.

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