Company Analysis Assignment for PEP. Accounting, Finance, Coursework

Company Analysis Assignment for PEP. Follow the requirement and make sure the answer right.

Company Analysis Assignment #3

This assignment requires some research, and two intrinsic value calculations for your stock(PEP.). 

1. Constant growth DDM (expanded formula).   Recall that P0 = E1(1-b)/(k-g), where E1 is EPS for the coming year, b is the plowback ratio, k is the market required rate of return for the stock, and g is the assumed constant growth rate of earnings.  Since b is the plowback ratio, 1-b is the payout ratio.  Also, since g = ROE x b (ROE is return on equity), the expanded valuation formula (which you will use in this part of the assignment) is P0 = E1(1-b)/(k-(ROE x b)). 

Regarding the inputs for the constant growth valuation, I think the easiest and safest way to get E1 is to just get the consensus estimate for 2019 (make sure you pick up the annual estimate, not a quarterly estimate) from MarketWatch or another legitimate source.   (If you use MarketWatch, just enter the stock symbol, click on “Analyst Estimates” tab, and then pick up the “mean estimate, this fiscal” number from the EPS table.)  Recent ROE and payout ratio (1-b, from which b can obviously be derived) can be found in the “Statistics” tab of YahooFinance.   These should be used as the basis for a going-forward projection of ROE and b (you may assume that they will change or not, but state what you are assuming and why) to be used in your valuation.   You have already computed k in assignment 2.

It is possible that your constant growth rate (g) will be such that (k-g) is negative, rendering the result meaningless.  This will most often occur for companies with a relatively-high current ROE.  As we discussed in class, this is typically a signal that the constant growth assumption is not applicable to your company, and that a multi-stage model (see below) is more relevant.  If this occurs, just set up the valuation equation (above, in bold) with your inputs, but do not solve.  State the problem (i.e. g > k) and the reason (high ROE, high plowback, or both).

1.  Two-Stage DDM.  You are to do a two-stage DDM model using the methodology described in class.  The first growth rate, or g1, is the growth rate projected for the next three (3) years.  The second growth rate, g2, is the constant projected growth rate beginning in year 4.  Recall that the total value calculated with the two-stage model consists of the PV’s of the first three years’ projected dividends, plus the PV of the terminal value projected for the stock as of year 3.  This terminal value is calculated using a constant growth valuation as of year 3.

The first growth rate, or g1, will depend significantly on the company that you are analyzing.  For example, if your company has been growing very rapidly, you might project a high rate of growth for the first three years, a rate that will be significantly higher than g2.  If your company is growing at a lower, more mature growth rate, you would likely use a similarly-low g1, a rate that will also be similar to g2.  You can estimate g1 in a number of simple and equally-acceptable ways.  First, you can look at EPS or dividends for the past few years, compute an average annual growth rate and use that as your g1.  Dividends can be found on YahooFinance as you know from doing assignment 1, and historical EPS can be found in the 10-K among other sources.  Or, sometimes the company provides a 5-year earnings growth rate among the summary statistics on its website or in its 10-K, which you may also use as g1.  Or you may take these numbers and adjust them as long as you state your reason for doing so.  Just state a brief reasonable basis for whatever you do, and cite your source.  (Note that g1 need not be the same g that you calculated for the constant growth model.)  As for g2, the only requirements are that it be a mature single-digit growth rate, that it be less than k, and that it be less than g1. 

Again, you have already computed k in a previous assignment and you should use this in your valuation.

1. Which model do you think worked better for your stock, and why?  Write a two- or three-sentence answer to this question.  Your reasoning should cite specific relevant facts.  For example, if the constant growth model didn’t work, don’t just tell me g > k.  Why was g > k?

*Important Regarding Valuation Inputs For Both Exercises:  You are NOT expected to provide detailed models or calculations justifying your projection of inputs, i.e. E1, g1, g2 etc.  All I want is a “back-of-the-envelope” reasonable basis and documentation.  This can be as simple as relating your projection to recent actual numbers.  For example:  “According to YahooFinance, LotsaDough grew EPS at an annual rate of 7% over the past five years.  Therefore, I am assuming that E1 will be 7% higher than the most recent year for the constant-growth DDM.”  Another example:  “EPS for Lotsa Dough grew at an annual rate of 15% over the past five years, but this was a recovery from a depressed base.  Therefore, I am projecting a lower g1 of 10% for the two-stage DDM, slowing further to a g2 of 5%.”

**A Word About The Results:  Do not worry if you have done all of the work correctly, but the results look unrealistic.  Remember that these models are very sensitive to changes in inputs (consider the effect of just a 1% change in k or g), and we are being necessarily crude with regard to some of these inputs.  DO worry if you have not followed the correct procedure, as this is what you will be graded on.

*** You are reminded that all submissions must be via regular Excel or Word email attachment ONLY.  PDF, pictures or handwritten assignments will NOT be accepted.  I strongly recommend Excel for this assignment.

****Note:  You must do the two-stage DDM whether or not you get a meaningful answer for the constant growth valuation.