Teaching Security Analysis using MSN and Value Line
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Teaching Security Analysis using MSN and Value Line Teaching Security Analysis using MSN and Value Line Document Transcript

  • Teaching Security Analysis: Equity Valuation Using Value Line and MSN Stock Screener by Walter P. Neely Professor of Finance Else School of Management Millsaps College Jackson, MS 39210 601-974-1263 601-974-1260 (fax) Neelywp@millsaps.edu For presentation to Financial Education Association Orlando April 2005
  • Teaching Security Analysis: Equity Valuation Using Value Line and MSN Stock Screener 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 2
  • 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, 3
  • 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 value method. 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 and customers. 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 4
  • 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 below. 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 5
  • 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 spreadsheet calculations. 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. 6
  • 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 7
  • 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. Conclusion 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 finance graduates. 8
  • 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 comparative appreciation. PORTFOLIO GUIDELINES: COMPANIES WITH: • 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 Model) • High ROE, ROA, and profit margins; demonstrated consistent earnings power • Low risk measures and strong financial condition OTHER FACTORS: 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. PORTFOLIO: 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. BONDS: Total return of fixed income instruments is stressed. DERIVATIVES: Calls and/or Puts may be used to reduce the risk of certain holdings. 9
  • Exhibit 2. Industry Analysis Spreadsheet Merck's Competitors and Other Comparable Companies Louis Wilson Fund Holdings Bristol Genzy Glaxo Renal Amer Cardinal Biogen Myers Forest me SmithK Abbot Scher. Watson Care Heal. Home Merck Amgen Health IDEC Sq. Labs Gen. ADR Lilly Eli Lab Novartis Plough Pharm. Pfizer Grp Way Depot Tickers MRK AMGN CAH BIIB BMY FRX GENZ GSK LLY ABT NVS SGP WPI PFE RCI AMHC HD Growth Rates (%)--MSN Sales (qtr. v yr. ago) -54.7% 32.6% 27.7% 336.0% 7.5% 29.2% 31.2% 5.7% 15.2% -0.4% 12.4% -8.2% 12.2% 22.8% 38.0% 56.3% 11.0% EPS (YTD v yr ago) 5.3% 30.7% 9.0% -100.0% -9.0% 27.9% NA 1.5% -3.8% 39.1% 19.5% -99.0% -17.2% 371.0% 24.6% 25.2% 19.8% Sales (5-yr avg) 4.6% 24.6% 19.5% 56.6% 1.3% 31.5% 22.8% 23.0% 5.7% 9.5% 17.7% -1.4% -19.0% 23.4% 17.6% 35.1% 13.1% EPS (5-yr avg) 4.8% NA 25.6% NA -7.5% 51.0% NA 10.2% 0.0% 2.9% NA NA 0.9% 1.8% 19.0% 73.8% 16.9% Financial Condition-MSN Debt to Equity 0.29 0.01 0.32 0.12 0.80 0.00 0.27 0.40 0.34 0.37 0.11 0.34 0.27 0.10 0.96 0.28 0.05 Interest Coverage 30.9 229.0 24.0 -69.0 16.0 NA 6.1 24.8 79.6 23.9 26.9 -27.7 16.9 -81.6 27.6 14.0 129.0 Leverage Ratio 2.5 1.3 2.6 1.3 2.8 1.2 1.5 4.0 2.2 2.2 1.6 2.1 1.5 1.8 2.6 1.6 1.7 Profit Margins (%)--MSN Gross Margin 85.0% 87.9% 8.2% 59.6% 66.6% 79.4% 78.6% 83.3% 82.3% 59.3% 82.7% 69.0% 56.4% 88.9% 34.4% 35.3% 34% Pre-tax Margin 40.0% 37.3% 3.7% -69.8% 21.6% 35.3% 10.7% 28.9% 24.6% 20.9% 23.9% 1.0% 18.5% 19.4% 18.7% 16.7% 11% Net Margin 28.8% 26.9% 2.4% -64.9% 13.6% 27.8% 5.5% 20.5% 18.6% 15.6% 20.6% -7.3% 11.8% 15.6% 10.0% 9.9% 7% 5 yr Avg Gross Margin 48.3% 91.6% 9.3% 84.9% 72.7% 79.5% 76.4% 82.4% 84.3% 59.5% 78.1% 80.0% 59.3% 87.7% 35.1% 49.5% 32% 5 yr avg Pre-tax Margin 25.3% 30.0% 3.4% -22.9% 21.8% 31.6% 3.4% 29.6% 31.0% 20.5% 25.1% 23.3% 26.7% 22.9% 18.0% 13.0% 10% 5 yr avg Net Margin 17.4% 17.4% 2.2% -32.2% 19.8% 23.9% -0.3% 21.0% 24.7% 15.7% 21.0% 17.7% 15.8% 18.1% 9.8% 7.6% 6% Investment Returns (%)--MSN ROE 39.1% 13.4% 19.6% NA 28.4% 22.5% 3.4% 81.2% 24.0% 24.7% 18.7% NA 8.6% 12.1% 22.2% 15.2% 21.1% ROA 15.9% 10.0% 7.5% -10.7% 10.2% 19.4% 2.3% 20.5% 11.1% 11.4% 11.4% -3.9% 5.8% 6.7% 8.7% 9.3% 12.4% ROC 30.4% 13.2% 14.8% NA 15.7% 22.5% 2.7% 42.8% 18.0% 18.1% 16.9% NA 6.8% 10.9% 11.3% 11.9% 20.1% 5 yr avg ROE 43.6% 8.4% 16.7% NA 41.4% 21.7% NA 57.8% 38.3% 25.3% 17.7% 24.7% 10.4% 21.9% 15.7% 11.2% 18.2% 5 yr avg ROA 16.4% 6.3% 6.6% -3.8% 16.4% 17.9% -0.1% 18.8% 16.4% 11.9% 10.9% 13.6% 6.8% 11.0% 11.3% 8.7% 12.3% 5 yr avg ROC 33.9% 7.4% 12.5% -4.3% 22.3% 21.7% -0.1% 42.2% 25.4% 19.5% 16.4% 23.0% 8.3% 18.0% 15.0% 11.2% 17.0% Management Efficiency--MSN Receivable Turnover 4.7 8.6 19.4 7.0 6.5 11.6 4.8 3.3 6.0 7.1 6.4 5.4 9.2 5.6 5.8 8.0 47.4 Inventory Turnover 1.1 1.7 6.5 4.5 4.3 1.1 1.8 1.7 1.3 3.3 1.4 1.6 1.8 0.8 37.8 NA 4.9 Asset Turnover 0.5 0.4 3.2 0.3 0.8 0.8 0.4 1.0 0.6 0.8 0.6 0.6 0.5 0.4 1.1 1.2 1.9 Valuation Ratios --MSN P/E 14.8 29.2 13.5 NA 16.1 21.6 NA 15.4 27.4 21.2 21.2 NA 17.6 28.2 20.6 43.0 18.2 P/E High (L5Y) 33.8 NA 50.9 NA 48.6 68.2 NA 47.3 39.7 57.7 NA NA 62.0 83.5 33.1 362.0 69.8 P/E Low (L5Y) 11.6 NA 15.0 NA 13.0 19.4 NA 11.6 17.4 16.5 NA NA 10.9 16.4 13.5 10.0 10.7 Price/Sales 4.2 7.5 0.3 13.3 2.2 5.9 6.6 3.1 5.3 3.3 4.3 3.4 2.1 4.4 1.9 4.1 1.2 Price/Book Value 5.8 3.7 2.6 2.9 4.5 3.9 4.1 12.4 6.8 5.2 3.9 3.9 1.5 3.4 4.2 6.3 3.8 Price/Cash Flow 12.5 22.0 11.0 -28.0 12.4 19.6 4.3 12.5 23.4 14.9 17.3 -18.6 11.3 16.8 13.3 23.3 15.4 Source: http://moneycentral.msn.com/investor/finder/customstocks.asp 10
  • Exhibit 3. Value Line sheet for Merck, Annotated. 11
  • Exhibit 4. Company Pro Forma Spreadsheet PRO FORMA WORKSHEET Merck COMPANY BASICS Ticker: MRK Dividend Yield: 4.5% Exp Growth (VL) 3.0% Ouma Model P/E Date: 10/25/2004 52 Week High/Low: 33-63 Lynch Ratio (>1) 0.2 Base Exp. Price $ 50 Price: $32.00 Debt Ratio: 23% Sector Healthcare Base Exp. Multiple 16 Last Dividend: $ 1.45 Shares Oustanding 2,222.0 Industry Pharm. Implied Multiple 24 P/E (next year's EPS) 13.8 Beta: 0.9 VL Financial Strength A++ Target Price $ 75 Risk and other ANALYSIS 1998 1999 2000 2001 2002 2003 2004E 2005E 2006E 2007E 2008E Times Interest Earned calc 32 25 19 22 25 23 26 31 37 44 51 Debt/Equity calc 0.25 0.24 0.24 0.30 0.27 0.33 0.27 0.23 0.22 0.16 0.15 GROWTH - PROFITABILITY - LEVERAGE NET RETURN ON EQUITY (In Millions) 1998 1999 2000 2001 2002 2003 2004E 2005E 2006E 2007E 2008E Net Profit Margin calc 19.9% 18.0% 16.9% 15.3% 13.8% 29.3% 33.3% 33.8% 32.9% 31.7% 31.0% Total Asset Turnover calc 0.84 0.92 1.01 1.08 1.09 0.55 0.50 0.50 0.50 0.50 0.50 Total Assets/Equity calc 2.49 2.69 2.69 2.74 2.61 2.59 2.39 2.38 2.57 2.32 2.36 Net Return on Equity calc 41.8% 44.5% 46.0% 45.4% 39.3% 42.1% 39.7% 40.1% 42.2% 36.7% 36.4% EBITDA Oper. Profit Margin VL 28.5% 27.7% 26.5% 24.1% 21.9% 42.0% 42.0% 43.0% 44.0% 44.0% 44.5% Merck 1998 1999 2000 2001 2002 2003 2004E 2005E 2006E 2007E 2008E Revenues 3.6% $26,898 $32,714 $40,363 $47,716 $51,790 $22,500 $20,975 $21,730 $22,512 $23,323 $24,162 EBITDA VL $7,666 $9,062 $10,696 $11,500 $11,342 $9,450 $8,810 $9,344 $9,905 $10,262 $10,752 Depreciation VL $1,015 $1,145 $1,277 1464 $1,488 $1,314 $1,370 $1,375 $1,425 $1,476 $1,529 EBIT calc $6,651 $7,917 $9,419 $10,036 $9,854 $8,136 $7,440 $7,969 $8,481 $8,786 $9,223 Other Income (exp) IS $1,816 $509 $1,494 $1,006 $1,159 $891 $0 $0 $0 $0 $0 Interest 6.0% $206 $317 $484 $465 $391 $351 $288 $255 $228 $198 $180 EBT calc $8,261 $8,109 $10,429 $10,577 $10,622 $8,676 $7,152 $7,714 $8,253 $8,588 $9,043 Taxes 29% $2,396 $2,352 $3,024 $3,067 $3,080 $2,516 $2,074 $2,237 $2,393 $2,491 $2,623 Net Income calc $5,865 $5,757 $7,405 $7,509 $7,542 $6,160 $5,078 $5,477 $5,860 $6,098 $6,421 Net Income (reference) VL $5,348 $5,890 $6,822 $7,282 $7,150 $6,590 $6,995 $7,335 $7,400 $7,400 $7,490 No. Shares VL 2,361 2,329 2,308 2,273 2,245 2,222 2,190 2,160 2,100 2,100 2,050 EPS VL $ 2.15 $ 2.45 $ 2.90 $ 3.14 $ 3.14 $ 2.92 $ 3.15 $3.35 $3.45 $3.55 $3.60 EPS calc $ 2.48 $ 2.47 $ 3.21 $ 3.30 $ 3.36 $ 2.77 $ 2.32 $ 2.54 $ 2.79 $ 2.90 $ 3.13 Total Assets BB $31,853 $35,634 $39,910 $44,007 $47,561 $40,587 $42,048 $43,562 $45,130 $46,755 $48,438 Total Equity VL/calc $12,802 $13,242 $14,832 $16,050 $18,201 $15,650 $17,610 $18,283 $17,544 $20,162 $20,559 ST Debt BB/VL $624 $2,859 $3,319 $4,067 $3,670 $1,700 $1,700 $1,700 $1,700 $1,700 $1,700 LT Debt VL $3,221 $3,144 $3,601 $4,799 $4,897 $5,096 $4,800 $4,250 $3,800 $3,300 $3,000 BOOK Value per share calc 5.42 5.69 6.43 7.06 8.11 7.04 8.04 8.46 8.35 9.60 10.03 Sales per share calc $11.40 $14.05 $17.49 $20.99 $23.07 $10.13 $9.58 $10.06 $10.72 $11.11 $11.79 MV Equity calc $155,793 $172,353 $170,762 $172,748 $115,618 $116,655 $100,740 $105,840 $113,400 $117,482 $102,733 Enterprise Value calc $159,014 $175,497 $174,363 $177,547 $120,515 $121,751 $105,540 $110,090 $117,200 $120,782 $105,733 Average Price VL/calc $ 66 $ 74 $ 74 $ 76 $ 52 $ 53 $ 46 $ 49 $ 54 $ 56 $ 50 Dividends per share VL $ 0.95 $ 1.10 $ 1.21 $ 1.37 $ 1.41 $ 1.45 $ 1.49 $ 1.54 $ 1.60 $ 1.66 $ 1.72 Data Source: Value Line Investment Survey. 12
  • 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 5.00% 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% 13
  • Exhibit 6. Summary Sheet for Merck Merck­MRK Analysts: Corbett Gibson and Matt Russell 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. • Management • 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? • Valuation • 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: Recent news: • Industry news • Same store sales recent results • EPS recent quarterly results compared to expectations 14
  • • What is the trend, are they beating expectations or failing? 15
  • REFERENCES 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, http://moneycentral.msn.com/investor/finder/customstocks.asp? Query=&tools=standard&target=%2Finvestor%2Ffinder%2Fcustomstocks%2Easp %3FQuery%3D, April 15, 2005. Rakers, Brent, Morgan Keegan equity analyst, unpublished presentation, February 28, 2005. Reilly, Frank K. and Keith C. Brown, Investment Analysis and Portfolio Management, Thomson-Southwestern, 2004. 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. 16