Discussion 2: Valuation of Stocks and Corporations
(A). Stocks of a company, once issued into the market at the beginning through the initial public offer
(IPO0, do not affect the company in any way. The company’s only interest is the IPO value and this is what
their concern is (Whaley, 2006). The organizational management mostly gets IPO prices and the traders in
the stock exchange market set the next set of prices. However stock prices are affected more by the short-
term performance of the company than the long term (Whaley, 2006). Things like inflation and interest
rates, exchange rates, release of new products and services are just but among the short term occurrences
that alter the performance of the company and there and then the prices of stocks in the stock exchange
markets (Whaley, 2006).
(B) Dividend discount model (DDM) is a way of assessing the value of a company’s stock price based
on the theory that its stock is worth the sum of all of its future dividend payments, discounted back to their
present value (Whaley, 2006). In other words, it is used to value stocks based on the net present value of
the future dividends (Whaley, 2006). The equation most widely used is called the Gordon growth model as
this model can be used to value a firm that is in “steady state” with dividends growing at a rate that can be
sustained
The variable parameters are:
: Is the current stock price.
: Is the constant growth rate in perpetuity expected for the dividends.
: Is the constant cost of equity capital for that company.
: Is the value of the next year’s dividends .
There is no reason to use a calculation of next year’s dividend using the current dividend and the growth
rate, when management commonly discloses the future year’s dividend and websites post it.
The equation can also be understood to compute the value of a stock such that the sum of its dividend yield
(income) plus its growth (capital gains) equals the investor’s required total return. Consider the dividend
growth rate as a proxy for the growth of earnings and by extension the stock price and capital gains.
Consider the company’s cost of equity capital as a proxy for the investor’s required total return.
RISK AND RETURN 2
This can be rewritten as
The issue with using this model is that the companies dividends is expected to last forever and the
companies measure of performance is expected to grow at the same rate.
The above is in hopes that I understand what is being asked in the second part of my answer with the
company I elected which is CVS. So if miss understood the above I’m really going to get the evaluation
incorrect!
Current CVS intrinsic stock price of $99.88 yet the current stock
price is $67.96 (as of 2:36pm Feb 1, 2014). However the stock has the potential to provide long-term
growth as it has in the past 52 weeks with a high of $71.99.
. When reviewing if someone should invest in CVS it
appears they are currently undervalued, yet there are several within their industry that are undervalued:
Ticke
r 1 Current
Stock
Price 1
Projected
Stock
Price 2 based
on Projected
P/E
Projected
Stock
Price 2 base
d on PEG
Projected
EPS 3
Projected
Company
P/E 3
Projected
Industry
P/E 3
click to sort
by:%
Under/Ove
rvalued
Projected
P/E5
Projected
Company
PEG 3
Projected
Industry
PEG 3
Projected
Growth
Rate 4
%
Under/Ov
ervalued
PEG5
BIOS $8.64 $4.41 $1.77 $0.23 37.57 19.16 96.07% 23.5 4.82 1.60%
387.89%
PMC $24.00 $28.55 $79.78 $1.49 16.11 19.16 18.95% 1.45 4.82 11.11% 232.18%
WAG $57.41 $74.53 $209.63 $3.89 14.76 19.16 29.82% 1.32 4.82 11.18% 264.90%
CVS $67.89 $85.65 $279.68 $4.47 15.19 19.16 26.15% 1.17 4.82 12.98% 311.68%
GNC $51.57 $66.68 $248.57 $3.48 14.82 19.16 29.29% 1 4.82 14.82% 381.67%
RAD $5.61 $6.51 $58.80 $0.34 16.51 19.16 16.08% 0.46 4.82 35.88% 947.10%
Shares of CVS Caremark Corp ( CVS ) are trading at a discount to the intrinsic value of the company’s
future earnings and free cash flows; strong growth can be bought, on sale, at these levels. Discounted cash
RISK AND RETURN 3
flow analysis suggests that current market price, $67.96, offers a long position and 18.223% upside, in
keeping with a $69.45 price target on CVS. The values used in DCF calculation are shown in the chart
below.
EPS Trends Current Qtr.
Dec 13
Next Qtr.
Mar 14
Current Year
Dec 13
Next Year
Dec 14
Current Estimate 1.11 0.98 3.96 4.47
7 Days Ago 1.11 0.98 3.96 4.47
30 Days Ago 1.11 0.97 3.96 4.47
60 Days Ago 1.11 0.95 3.96 4.46
90 Days Ago 1.14 0.94 3.95 4.45
EPS (Current Year Dec ’13) 3.96
10 Year Growth Rate 12.8
%
Terminal Growth Rate (Current
Inflation)
2.00
%
Years of Terminal Growth 5
Discount Rate (Avg. Return S&P 500) 9.3%
References:
Finance.yahoo.com, 2014.
Freestockvalueranker.com, 2014.
1&method=peg_pe&symbol=SHLD&found=1&field=value_industry_peg.
Marketwatch.com, 2014.
Whaley, R. (2006). Derivatives, Markets, Valuation and Risk Management. New Jersey: John Wiley and
Sons.
Valuepro.net, 2014.
