Assignment Stock Market Valuation

PART-1 : 1. Banque Populaire case 1. Investment selection process:

Step 1: Gather the above Statements of the company you are interested to invest in Step 2: Find the Ratios: liquidity ratio, activity ratio, debt ratio, profitability ratio. Step 3: Analysis these ratio for the company and the competitors, Compare the corporations, analyse the trend (performance of the company over years) of the company, compare the performance of the company and other companies over years. 2. The Models that can be used are to estimate the companys equilibrium market price and equilibrium market returns: a. Dividend discount model

where Po is the equilibrium price D1 is the Dividend per share

g is the dividend growth rate Re is the cost of equity Strengths: i. Simple ii. Provides you with a way to value stocks based on the dividends iii. Helps in relating monetary policy and stock valuation iv. Helps in relating financial crises with stock valuation Weaknesses: i. An assets price is a rational best guess of its true value, that is, the estimated present value of the cash flows to the share. This model ignores the impact of noise trading on price dynamics. ii. The model assumes that we know what dividends will be paid be next year E(D1) iii. The model requires the assumption that the dividend growth rate g is known and is stable over time. iv. Proposed estimation of equilibrium returns is not related to risk levels b. Dividend discount with endogenous growth forecasts

where Po is the equilibrium price ret is retention rate ROE is return on equity Re is the cost of equity Strengths: i. More sophisticated than the standard dividend discount model: g is modelled too (rather than being assumed) Weaknesses: i. ii. iii. Assumes no noise trading Assumes that ret and ROE are forever constant Requires a good forecast for EPS1 (next years earnings per share)

c. Abnormal earning methods

Strengths: i. Infers the assets equilibrium price based on its book value and explicit forecast earnings for the next years

Weaknesses: i. ii. 3. a) Dividend discount model -> 9.36/8%-3% = Euro 187.2 b) Dividend discount with endogenous growth forecasts
( )

Assumes perfect abnormal earnings forecasts. Assumes no noise trading

= (1-0.52)*0.05/Po + .52*.07 Po = Euro 181.67 c) Abnormal earning methods Ebook = Net Book Value / No. of shares=2,000,000 / 15,000= 133.3 Re= 8% Abearnings = EPS - RE*Ebook = .05 (0.08* 133.3) = -10.62 P0 = Ebook + (Abearn / (1+RE)t) = 133.3+ (-10.62/(1+.08)) = Euro 123.49

4. Current Stock Price = Euro 58

MODEL Dividend discount Dividend discount with endogenous growth Abnormal earnings method PREDICTED PRICE Euro 187.2 Euro 181.67

Euro 123.49

All the models show that the current price is undervalued and hence can be bought.

PART-2: 2. Internet exercise: stock comparison The companies taken for this exercise: LAFARGE VICAT Both the companies are French cement producers, hence are in the same industry.

Source of data: Annual reports 2012

http://www.lafarge.com/04032013-press_publication-2012_annual_report-uk.pdf

1. Ratio Analysis LAFARGE ( in million euro) 1. Liquidity Ratios a. Current Ratio= Current Assets / Current Liabilities = 9284/7265 = 1.28 b. Quick Ratio= (Current Assets Inventory)/Current Liabilities =(9284-1662)/7265 = 1.05 2. Activity Ratios a. Inventory Turnover= COGS/Inventory= 11945/1662 = 7.19 b. Fixed Asset Turnover= Sales/Net Fixed Assets = Sales/(Intagible Assets +Tangible Assets- Depreciation and Amortization )= 15816/(12804+14992-1010) = 0.59 c. Average Collection Period = Accounts receivable/Average sales per day= (2541*365)/ 15816 = 58.64 d. Total Asset Turnover = Sales/Total Assets= 15816/39464 = 0.40 3. Debt Ratios a. Debt Ratio= Total Liabilities/ Total Assets= 21714/39464 = 0.55 b. Debt-Equity Ratio= Long term Debt/ Shareholder Equity =11261/15668= 0.72 c. Times Interest Earned = EBIT/Interest = 1947/1191= 1.63 d. A/E= Total Assets/ Shareholders Equity = 39464/15668 =2.52 4. Profit Ratios a. Gross Profit Margin= Gross Profit/Sales = (Sales - COGS)/Sales = (1581611945)/ 15816 = 0.24 b. Operating Profit Margin= EBIT/ Sales = 1947/15 = 0.12 c. Net profit margin = Net Income/ Sales =621/15816 = 0.04 d. EPS = Net Income/No. shares of common stock = 621,000/287,079= 2.16 e. Return on Total Assets = Net Income/Total Assets= 621/39464= 0.016 f. Return on Common Equity= Net Income/Shareholders Equity= 621/15668= 0.04

VICAT ( in thousand euro) 1. Liquidity Ratios a. Current Ratio= Current Assets / Current Liabilities = 1150027/703184 = 1.63

b. Quick Ratio= (Current Assets Inventory)/Current Liabilities =(1150027381893)/703184 = 1.09 2. Activity Ratios a. Inventory Turnover= COGS/Inventory= 1461292/381893 = 3.83 b. Fixed Asset Turnover= Sales/Net Fixed Assets = Sales/(Intagible Assets +Tangible Assets- Depreciation and Amortization )= 2292219/(3386504-191587) = 0.72 c. Average Collection Period = Accounts receivable/Average sales per day= (354877*365)/ 2292219 = 56.51 d. Total Asset Turnover = Sales/Total Assets= 2292219/4771894 = 0.48 3. Debt Ratios a. Debt Ratio= Total Liabilities/ Total Assets= 2306958/4771894 = 0.48 b. Debt-Equity Ratio= Long term Debt/ Shareholder Equity =1197703/2130798= 0.56 c. Times Interest Earned = EBIT/Interest = 245228/34443= 7.11 d. A/E= Total Assets/ Shareholders Equity = 4771894/2130798 =2.24 4. Profit Ratios a. Gross Profit Margin= Gross Profit/Sales = (Sales - COGS)/Sales = (22922191461292)/ 2292219 = 0.36 b. Operating Profit Margin= EBIT/ Sales = 245228/2292219 = 0.11 c. Net profit margin = Net Income/ Sales =147965/2292219 = 0.06 d. EPS = Net Income/No. shares of common stock = 147965/2513320= 2.87 e. Return on Total Assets = Net Income/Total Assets= 147965/4771894= 0.03 f. Return on Common Equity= Net Income/Shareholders Equity= 147965/2130798= 0.07

LAFARGE Liquidity Ratios Current Ratio Quick Ratio Activity Ratios Inventory Turnover Fixed Asset Turnover Average Collection Period Total Asset Turnover Debt Ratios Debt Ratio Debt-Equity Ratio Times Interest Earned 1.28 1.05 7.19 0.59 58.64 0.4 0.55 0.72 1.63

VICAT 1.63 1.09 3.83 0.72 56.51 0.48 0.48 0.56 7.11

A/E Profit Ratios Gross Profit Margin Operating Profit Margin Net profit margin EPS Return on Total Assets Return on Common Equity

2.52 0.24 0.12 0.04 2.16 0.016 0.04

2.24 0.36 0.11 0.06 2.87 0.03 0.07

Yellow highlighted values signify better performance. Almost all the ratios are better for VICAT.

2. DU PONT ANALYSIS:

Company LAFARGE VICAT

DU-PONT ANALYSIS Net profit Total Asset margin Turnover ROA 0.04 0.06 0.4 0.48 0.016 0.0288

A/E 2.52 2.24

ROE 0.04032 0.064512

VICAT has a lower leverage as A/E low. Asset Turnover for VICAT is higher. Net Profit Margin is also higher for VICAT there VICAT earns more.

3. According to the above analysis I would recommend to buy VICAT as it is better than its industry counterpart LAFARGE in almost all the aspects.

4. VICATs 5 year Average Dividend per share: Euro 1.46

VICATs Dividend Growth for 5 years = 3.845% Current Share Price = Euro 57.26 RE=(D/P)+g= (1.46/57.26)+0.03845 = 6.395 % Market Return = 6.78% (Source: Reuters.com) Since the observed return is more than equilibrium return hence but the stock. 5. EPS for VICAT = 2.87 Retention Rate= (Net Income Dividends)/Net Income = (147965 87993)/147965 = 40.53% ROE VICAT= 6.45% RE=(1- ret)*EPS1 + ret*ROE= (1-0.4053)*0.0287 + 0.4053*0.0645 =4.32% As Equilibrium Return smaller than observed return hence buy stock.

6. EPS for VICAT = 2.87 Ebook = Net Book Value / No. of shares=2130, 798,000 / 44,900,000= 47.45 Re= 5.99% (Source: Reuters.com) Abearnings = EPS - RE*Ebook = .0287 (0.0599* 47.45) = -2.85 P0 = Ebook + (Abearn / (1+RE)t) = 47.45+ (-2.85/(1+.0599)) = 44.76 Since. Observed price is more than the equilibrium price, hence dont buy. 7. From the fundamental analysis it was clear that LAFARGE is an underperformer as compared to VICAT in the cement sector. The DDM model, DDM model with endogenous growth both showed result in favoring VICAT. Though observed price came to be more than the equilibrium price calculated by Abnormal Earnings Method. In spite of the result shown by abnormal earnings method VICAT has shown strong fundamentals and growth prospects and hence it is a good option for investing.