Analysis Assignment Paper on The Bovis PLC (Essay Sample)

Analysis of Bovis Homes PLC
Name
Course
Professor
University
Date
Task 1
a. £m
Net asset value in Bovis homes plc 1630
Property, Plant and Equipment 50
Debtors (10)
Revised NAV in BP plc 1670
b.
1. Ke = rf + β(rm-rf)
When β is 0.8 Ke=3%+ 0.8 (6%-3%) = 3%+0.8 x 3% = 5.4%
When β is 0.1 Ke=3%+ 0.1 (6%-3%) = 3%+0.1 x 3% = 3.3%
2.
3.
Vd should be adjusted because the figure illustrated in balance sheet is par value, their market value should be 820p per share in terms of share price at 31 December 2016 in the LSE.
Therefore,
Ve=134*8.2=1098.8m pounds
Vd=170*90/100=153m
Kd=2.67%
When ke is 5.4%
When ke is 3.3%
C.
When Ke is 5.4%, g=0%, The theoretical price is
When Ke is 5.4%, g=2%, The theoretical price is
When Ke is 3.3%, g=0 the theoretical price is
When Ke is 3.3%, g=2% the theoretical price is
D.
EPS in 2015 is 90p
Market price on 31 December 2015 is 1015p
Market price on 31 December 2016 is 820p
The P/E ratios for the year 2015 and 2016 are 11.28 and 9.11 respectively. The average P/E ratio for the company’s industry is 12, which is higher than both of the P/E ratios. This implies that the market does not have a lot of confidence in Bovis Homes PLC future earnings. The P/E ratio has also decreased from 11.28 in the year 2015 to 9.11 in the year 2016. The ratio getting worse implies that investors are losing confidence in the ability of Bovis Homes PLC to sustain its current earnings in the future. The P/E ratios for Bovis Homes PLC in the two years show that other firms in the same industry as Bovis Homes PLC have a greater potential of getting higher earnings, or that they have a lesser risk.
Task 2
(a)
Definition of P/E
Price to Earnings ratio is one of the most familiar common stock valuation methods and has been used since the early 20th century. P/E ratio is obtained by dividing the market price of a share (numerator) with Earnings Per Share (denominator) (Koller, Goedhart and Wessels, 2010). There are several justifications that support P/E in the valuation of stocks. First, earning power is considered the main driver of investment value. EPS then becomes the primary focus of investors and security analysts as it shows the earning power of the firm. Second, P/E ratio is widely used and recognized by investors across the globe. Third, a difference in P/E ratio may be related to a difference in the average returns on investment in those stocks. These grounds make many investors decide P/E ratio as the ratio of choice when deciding on which security to invest in.
However, selecting the figure of EPS which is appropriate is not as straightforward as the figure of the current market price of the stock. The first issue dealt with when selecting the EPS figure is time horizon over which earnings of a stock has been measured. The second issue is the modifications to accounting earnings that an analyst makes to compare P/Es of different companies.
There are two types of P/Es: a trailing P/E and a forward P/E. A trailing P/E is also called a current P/E and is calculated by dividing the current market price of stock by the four most recent quarters of EPS. The EPS in this calculations is sometimes called “trailing 12 month EPS” (Campbell and Thompson, 2008).
TrailingPE=Current Market Price Per SharePrevious 12 months EPS
The forward P/E is sometimes referred to as the prospective or leading P/E. It is calculated by dividing the current market price per share by the forecasted future earnings for the next 12 months EPS (Damodaran, 2012).
FowardPE=Current market price per shareExpected EPS for the next year
The advantage of using the forward P/E over the trailing P/E is that it helps investors make decisions based on the predicted performance of the company in the coming year rather than use historical data. The trailing P/E can be affected by uncertainties the earnings growth in the future. Hence, many investors prefer a prospective P/E as the valuation of a stock is a progressive process(Pinto, Henry, Robinson and Stowe, 2010). The trailing P/E may be used when it is difficult to predict the future earnings of a company or when the forecasted future earnings are deemed unreliable by an analyst.
A higher P/E is preferred since it is an indicator that the earnings of a particular company are expected to grow in the future. Also, when analyzing a company in a certain industry, it is important to compare its EPS with the average EPS of the industry. If it has a higher EPS than the average EPS, that implies that it is expected to grow its earnings than most of its peers. However, if its EPS is lower than the average EPS, it means that its earnings will grow slowly than the industry itself (Jitmaneeroj, 2017).
Advantages of P/E
P/E ratio is an easy method to use in valuing worth of a company’s shares. It can be used even by people who are not well conversant with finance. To calculate it needs just dividing two figures, and the analysis is that the higher it is, the more expectation of future earnings growth. This is one of its main advantages, and even though it is a basic method and tool of analyzing the worth of stock, it can be used in making quick decisions.
The P/E ratio is a better indicative means of the real value of a stock compared to the price alone. For example, a stock with a price of USD 50 and a P/E of 5 is much cheaper than a stock with a price of USD 5 and a P/E of 50. This applies if the two stocks are from the same industry. P/E can be used as an excellent tool for benchmarking stocks about the average of the industry or specific competitors.
Disadvantages of P/E
The first limitation of P/E is that it is subjective in nature. Stock prices are usually volatile, and it is estimated that 40 – 100 investors who are the most active influence more than half of the stock prices change (McMilan, 2015). Also, then there is an optimistic sentiment in the economic and business environment, stock prices tend to increase hence raising the P/E. During a recession in the economy, stock prices are undervalued lowering the P/E.
Inflation is also a factor that influences the size of the P/E ratio. During inflation, earnings from a foreign country, or to a foreign country can be devalued hence creating a higher P/E. The inflation will cause the share price of the company to decrease and hence an overvaluation of the stock (Wei, 2010).
Another disadvantage of P/E is that its interpretation is problematic. Two different analysts can come up with different recommendations using the same figure of P/E ratio. While one investor may consider a specific P/E ratio too low, another may view it as too high. This variation in the perception arises from the fact that the P/E ratio is solely a matter of the current market price of the stock.
Dividend Growth Model (DGM)
The dividend growth model is a method used by investors to measure the value of a firm’s stock. An investor becomes a shareholder of a company by buying its stocks and letting it use his or her money to meet the financial needs. In return, the company pays the investor dividend, which is profit for the funds invested. The dividend growth model is also called the dividend discount model since it gives insight into whether a stock is on sale. When using this method, investors do not take into considerations the customer loyalty or brand name. It takes into account the dividends to be paid next year, required rate of return or cost of capital and the growth rate of the dividends (Barth, Konchitchki and Landsman, 2013). The stock value can be calculated by the formulae below, which is applicable when there is a constant growth rate (Ohlson and Gao, 2006):
Stock Value=D/(k-g)
Where:
D – is the next year’s expected annual dividend per share.
k – is the required rate of return or the lowest rate an investor would accept to buy the stock.
g – expected growth rate of the dividend.
Advantages of DGM
This method is easy to use it, and anyone can understand it well compared to other valuation methods such as discounted cash flow method. It requires only three variables, which once they are obtained, it is easy to calculate the value of stock.
Secondly, this model has a logical and sound basis. It is based on the fact that stocks are purchased by investors so that they can receive payments in the future. Even though investors can buy stocks for a various number of reasons, the basis is that they would like a return on their money at some point.
Thirdly, this model can be reversed and used to determine growth rates as predicted by experts. If investors know the predicted price per share of stock, then they can use the model to calculate the expected dividends. Expected dividends are useful to investors as they can know their expected earnings.
Disadvantages of DGM
The first limitation of using this method is that it only applies to companies that issue dividends. This type of valuation cannot be done to companies that are not issuing dividends. Though many companies that are trading their stocks issue dividends, some few companies do not issue dividends for various reasons.
The dividend growth model reflects rationality but not reality. Investors normally should invest in stocks that pay them the highest dividends. However, at times investors behave differently than they should behave. An investor may purchase a company not for its financial status or future dividends but for the fact that it is interesting or glamorous. This is the reason as to why there is usually a discrepancy between actual market value and intrinsic value.
Thou...