Teaching Security Analysis using MSN and Value LineDocument Transcript
Teaching Security Analysis: Equity Valuation Using Value Line and MSN Stock
Walter P. Neely
Professor of Finance
Else School of Management
Jackson, MS 39210
For presentation to
Financial Education Association
Teaching Security Analysis: Equity Valuation Using Value Line and MSN Stock
Teaching equity valuation is a component of many investments, security analysis, or
portfolio management courses including student-managed funds courses. Today there
is more and more evidence that markets are not as efficient as we once believed, either
overall and certainly for individual stocks (Jensen, 2004). Valuation in a less efficient
market should become a more important topic in future investments courses. Often the
subject of valuation is abbreviated in otherwise excellent and established leading texts
like Bodie, Kane and Marcus (BKM), 2002 and Reilly and Brown (RB), 2004. These and
other texts may rely on a simplified dependence on concepts and formulas described as
discounted cash flow (DCF) or the analogous term Dividend Discount Models (DDM).
Both texts include chapters on financial statement analysis that adds little to what is
covered in the basic junior-level finance course. Some books (Stowe, Robinson, Pinto
and McLeavey (2002), and Damodaran 1996) do excellent jobs on valuation, especially
the use of multiples in determining relative value. The widely used books cover topics
such as market efficiency and portfolio theory and management. These textbooks do
little to explain the ways investment bankers and portfolio managers exercise the
security analysis aspect of their professions. More attention to security analysis is often
required by courses involving student-managed funds as shown in survey results by
Neely and Cooley (2004).
Projects involving company analysis using current information are not new to
finance courses or professors. Stohs (1999) describes a company valuation project
used in a corporate finance course. He includes pro forma financial statements in the
process of seeking the intrinsic value of the firm. Kalra and Webster (2004) present a
project that facilitates learning by students in the first investments course. Students
gain a better understanding of stock returns, beta calculation, growth rates, and required
return calculations. Many of these recommended exercises utilize Value Line data, and
similar exercises combined with Value Line are employed in this paper.
A recent article by Hoover and Sterbenz (2003) represents another building block
for the current paper. Hoover and Sterbenz look at companies in the same industry,
valuing the firms five years into the future based on their projected growth. Their DDM
model utilizes the projected dividends plus the terminal value based on a projected P/E
ratio times the projected year five EPS. The projected P/E ratio is set equal to the
average industry P/E ratio. In the current paper we recommend basing projected P/E
ratios on Value Line estimates with adjustments based on analyst projections of growth
and risk. We use a DDM approach with a terminal value that utilizes the product of
market multiples times the relevant projected variable.
This paper deals with a similar approach to equity valuation that relies on
generally available information sources. We utilize stock internet-based screening to
meet stated strategies. As part of this screening process we obtain industry firm specific
comparable data. Concepts involved in the security valuation exercise include producing
pro forma income statements and abbreviated balance sheets, and using the projected
values to project a valuation of the stock of the company in question.
Equity Analysis by the Book
The coverage of equity security analysis by RB and BKM includes coverage of
financial statement analysis (FSA) including analysis of growth, risk, asset management,
profitability, and valuation ratios. These books’ FSA chapters build on the subject
coverage from the junior-level corporate finance courses. Another topic covered in the
widely used texts is industry analysis. RB include two excellent, although extended,
chapters on economic and industry analysis, while BKM combine, in good fashion,
economic and industry analysis in a single chapter. Application of FSA and industry
analysis is recommended and facilitated with the approach recommended in this paper.
While far from a complete coverage the recommended approach forces students to
apply the rather abstract coverage by the widely used investments texts.
Two chapters in RB cover equity valuation and company analysis. BKM
combine FSA and company valuation. Both texts extensively cover the DDM theory with
extensive discussions of the effects of growth and the discount rate on the P/E ratio.
RB extends its DDM coverage with cursory coverage of free cash flow to equity,
although not sufficient for most students to understand the methodology. RB does
cover relative valuation better than BKM. Hence, use of market multiples is covered,
but not sufficiently in either text, but is covered well in Stowe, et al, and Damodaren. In
this paper the method recommended is a combination of the DDM method and relative
Security analysis in practice (Rakers, 2005) requires a detailed knowledge of the
industry and the ways the industry’s firms are affected by the economy. Students of
security analysis should understand the relationships between economic variables and
industry variables. The identification of competitors is the next step, and thorough
knowledge of public, foreign, and even private firms is important. It is also important to
identify similar firms, i.e. firms facing similar market conditions, and to identify suppliers
Equity Analysis with Current Data
Screening to meet stated strategies may be accomplished in various ways
utilizing the Internet, using Value Line software and by various “manual” methods. In the
approach recommended in this paper, MSN Stock Screener (2005) is used with
screening criteria based on ratios such as ROE, ROA, growth, profit margins, etc.
These criteria are based on stated strategies, such as are shown in Exhibit 1. While the
selected company, Merck, is a firm with many attributes matching the criteria, its growth
prospects and drug pipeline are causes for concern. The analysis presented in this
paper was initiated prior to the Vioxx controversy and adjustments will be discussed
Industry analysis is facilitated using MSN Stock Screener data taken directly from
the Internet. While industry averages may be found in many Internet or other sources,
the recommended approach is to select comparable companies based in part on input
into MSN Stock Screener. Comparative analysis is then performed to identify strengths
and weaknesses of the subject company versus the comparative group.
The task of selecting comparable companies forces the student to select
comparable companies using Value Line or Internet sources. The comparable group of
companies should include analysis of product mix and other factors characterizing each
company. This review may force the student to better understand the products and
markets of the subject company. An understanding of factors driving the valuation of
the companies in the comparable group facilitates valuation of the subject company.
MSN Stock Screener produces both a (long) list of comparable companies and a
good representative set of ratios and growth rates, including valuation ratios, for each
company. Exhibit 2 shows data on selected companies exported from MSN Stock
Screener to a spreadsheet format, then copied-pasted-transposed to the present format.
The selected ratios should be examined to show the companies with particular strengths
with a focus on how these strengths affect each company’s valuation. Analyzing these
ratios helps the analyst to determine appropriate inputs to the valuation models for the
subject firm, and the strengths and weaknesses may be highlighted for later analysis as
shown in the exhibit.
Before a valuation model can be employed the historical and forecast financial
statements of the subject firm must be obtained/forecast. Value Line covers 1600 of the
largest companies with extensive historical and forecast data. Even if your subject
company is not included in Value Line’s 1600 companies, forecasts may be based on
similar companies from the 1600. Exhibit 3 shows the Value Line page for Merck. Pro
forma 2004 through 2007-2009 (we assume 2008) forecasts are shown for items like
sales, margins, and earnings for each of 1600 firms. The company pro forma
spreadsheet for Merck, shown in Exhibit 4, and it is based on historical data financial
statement data from Value Line and from company data taken from MSN, Yahoo,
Bloomberg, the SEC’s Edgar database, and other similar sources. Historical data
obtained from Value Line are sales, operating (EBITDA) margins, depreciation, taxes,
number of shares, equity, long-term debt, and average price and dividends per share.
Data obtained from other sources include other income, short-term debt, and total
assets. The projections for 2004-2008 are initially based on Value Line’s projections and
Since the data are input into a spreadsheet, the impact the Vioxx withdrawal from
the market news was based on the complete reduction of all Vioxx sales as given in the
Merck annual report. Value Line’s sales estimate for Merck is reduced from the given
estimates for 2004-2008. Analysis of the Merck annual reports suggests that Vioxx
sales are $2.4 billion, and we have deducted that full amount from the Value Line
estimate. In addition the impact of potential lawsuits is reflected in other
income/expense, which was reduced by $1 billion per year for the next four years—
maybe too little?
The spreadsheet valuation model shown in Exhibit 5 is a DCF model utilizing
Value Line’s estimates (as modified) of dividends, earnings, book value, etc. The pro
forma dividends are compounded to a future value and added to a terminal-2008 value
estimate. The 2008 terminal value estimates may be based on the spreadsheet tabs
using the following models: P/E, P/BV, P/CF, P/S, P/EBITDA, and P/Enterprise Value.
The P/E terminal value model is shown below with the future P/E ratio based on Value
Line estimates, high and low values from the company’s history taken from Value Line,
MSN, or Bloomberg. The mid P/E, sales, EBITDA margin, etc. for 2008 are based on
the Value Line estimate, as shown on the annotated Value Line page for Merck in
Exhibit 3. The future values of dividends and the P/E based selling price are summed
and present valued to determine the “indicated present value” or “intrinsic value.” Then
a Graham and Dodd-like “margin of safety” is applied to determine a targeted buying
price. Comparison of expected and CAPM-required returns is enabled.
An example analysis of Merck is shown in the spreadsheets that follow. The first
is the industry analysis spreadsheet. Second is the pro forma spreadsheet with data
and certain projections from Value Line. Other inputs are calculations or values from
the company’s financial statements or from the analyst. Exhibit 6 is the P/E tab of the
spreadsheet with the DCF/Relative value calculation, the one shown having a terminal
value based on the estimated future P/E ratio. There are high and low P/E multiples for
the terminal value estimates. The high and low estimates are based on past highs and
lows that are found on Exhibit 2 from MSN and may also be found from Bloomberg and
other sources. Care must be taken in selecting reasonable estimates of future high and
low P/E (or any valuation) multiples. In practice very high (e.g. 35 times or higher) and
very low P/E multiples are considered unreasonable, and the need for other valuation
models is called for.
The valuation targets are summarized on Exhibit 6 that is based on the format of
the student-managed fund, the Louis Wilson Fund. The key factors driving the
company strategy are summarized in “bullet point” format. This narrative should be well-
written to clearly indicate the analyst’s understanding of the company and the insights
gained from thorough analysis. Some of these insights would come from the industry
spreadsheet and other from the company pro forma spreadsheet. Other insights come
from reading the company’s annual report, brokerage firm reports, articles about the
company and its industry, etc. The second area of focus on the company summary
sheet focuses on risk, with insights from similar sources. The third focus area is
valuation, based on the DCF analysis shown in Exhibit 5. Other information on the
summary sheet may include current news and recent earnings announcements
considered important to the analyst.
The valuation models recommended combine aspects of DCF and relative
valuation models. The relative valuation models employ an analysis of ratios and
multiples, and these data are taken from Value Line and sources like MSN Stock
Screener from the Internet. A spreadsheet template allows the user to implement
equity valuation by initially replicating Value Line’s valuation. Further sensitivity analysis
becomes possible with easily implemented changes to the spreadsheet. With these
sensitivity analyses, ranges of possible values are enabled. Students can then better
understand how professional security analysts do equity valuation. More important they
understand valuation beyond the abstract formulas found in most texts.
The approach recommended in this paper utilizes generally available sources,
principally Value Line and MSN Stock Screener in conjunction with spreadsheet
templates. This approach can be an added component of the traditional text based
courses to improve the coverage of equity security analysis. It can also be added to
any course in investments or security analysis to add a real time exercise in establishing
the valuation of a stock. The recommended approach reinforces important skills in
accounting including the forecasting of financial statements. In addition important skills
in industry analysis are reinforced. Finally spreadsheet proficiency is encouraged.
These analytical skills when coupled with a well-written narrative are needed by today’s
Exhibit 1. Strategy Statement for Stock Screening
OBJECTIVE: LONG TERM CAPITAL APPRECIATION
The Wilson Fund maintains a policy of capital appreciation through investment
in securities judged to be undervalued and thus positioned for significant
• Excellent Management and strong business franchises.
• Evidence of growing markets and/or market share.
• Low Market/Book Value and high growth/PE ratio (Lynch Ratio)
• High rate of return based on a discounted cash flow model (The Ouma
• High ROE, ROA, and profit margins; demonstrated consistent earnings
• Low risk measures and strong financial condition
The focus of the selection process is the search for undervalued securities.
Growing companies in growing industries are favored.
Companies that are understandable and have low institutional following are
good candidates for original security analysis.
In order to understand each company, we target holding no more than 12
investment positions diversified by industry.
In order to minimize transaction costs, low portfolio turnover is preferred.
Total return of fixed income instruments is stressed.
Calls and/or Puts may be used to reduce the risk of certain holdings.
Exhibit 5. Valuation Using DCF and P/E Ratio Terminal Value
OUMA IPV Model P/E
MRK 1 2 3
year Growth 2005 2006 2007 2008
Dividends 3.00% $1.54 $1.58 $1.63 $1.68
FVIF @ Bond rate 5.00% 1.05 1.1025 1.157625
FV $1.78 $1.75 $1.71 $1.68
FV sum div $6.92
EPS rate clac 7.30% $ 2.54 $ 2.79 $ 2.90 $ 3.13
IPV Calculation VL est. Bloomberg
P/E Range 16 33 12
Term Val 2008 $50 $103 $38 Target Selling prices
sum div $6.92 $6.92 $6.92 during the next 3-4 years
FV yr 3 $57 $110 $45
PV @ Indicated Present Value Range
$49 $95 $38
Margin of Safety (25-40%) 30% $ 34 $ 67 $ 27 Target Buying prices
Current Price $32 Today
Expected Return 21% 51% 12%
Required Return 8.6% 8.6% 8.6%
Exhibit 6. Summary Sheet for Merck
MerckMRK Analysts: Corbett Gibson and Matt
PRICE: $28 52 Week Range: $45 – $23
Company Rating: Buy, Moderate to High Risk
Purchase: 400@$27 Holding Period 3-4 years
Target sell price: $ 75 Basis for Target Price: Ouma P/E of 24x
• Key Factors
• Product Strategy.
• Fit with Economic projections
• Industry – Porter analysis conclusions
• Competition – how does the firm fit
• Historical Earnings model comments
• Factors driving projections
• Growth Potential– comments from industry sheet
• Margins– comments from industry sheet
• Profitability– comments from industry sheet
• Investment Returns– comments from industry sheet
• Management Efficiency– comments from industry sheet
• Valuation – comments from industry sheet
• Does it fit the LWF strategy? Why?
• Risks – Why they may not succeed
• Key risks in product strategy
• Key risks of competitive analysis
• Financial Condition – comments from industry sheet
• Variability in sales, margins, etc. from pro forma
• Debt / TIE from Proforma
• Why might growth be slower than projected?
• Why may margins be lower than projected?
• Price relative to last 5 years and last 52 weeks
• Price multiples from Industry sheet compared to competitors and LWF firms
• PE HI LO from industry sheet compared to competitors and LWF firms
• Ouma assumptions
• Ouma model used PE, PCF, PBV, EV/EBITDA, etc.
• Ouma conclusions
• Ouma with MofS
Business Trends and Current Quarterly Results:
• Industry news
• Same store sales recent results
• EPS recent quarterly results compared to expectations
• What is the trend, are they beating expectations or failing?
Bodie, Zvi, Alex Kane, and Alan J. Marcus, Investments, McGraw Hill-Irwin, 2002.
Damodaran, Aswath, Investment Valuation, Wiley, 1996.
Hoover, Scott A. and Frederic P. Sterbenz, “A Reality-Based Method for Valuing
Stocks,” Journal of Financial Education, Spring 2003, pp. 49-65.
Jensen, Michael, speech to the FMA Annual Meeting, October 2004.
Kalra, Rajiv and Marsha Weber, “A Comprehensive Stock Analysis Project For The First
Course in Investments,” Journal of Financial Education, Summer 2004, pp. 44-55.
MSN Money Stock Screener,
%3FQuery%3D, April 15, 2005.
Rakers, Brent, Morgan Keegan equity analyst, unpublished presentation, February 28,
Reilly, Frank K. and Keith C. Brown, Investment Analysis and Portfolio Management,
Stohs, M., ‘Teaching Corporate Finance by Valuing a Corporation,” Journal of Financial
Education, Fall 1999, pp. 66-74.
Stowe, John D., Thomas R. Robinson, Jerald E. Pinto, and Dennis W. McLeavey,
Analysis of Equity Investments: Valuation, AIMR, 2002.
Value Line Investment Survey, July 23, 2004, Merck page.