The calculation represented in the above table directly highlights the model, which is being used by Analyst A for valuing the share price of the organisation. The analyst directly believes that there is no possible increment in growth that will be achieved by the organisation in near future. Moreover, the analyst assumes that the company will be profitable in nature but will not grow and remain the small regional company. The analyst assumes that the total earnings per share are paid 100% as dividends to the investors, which helps in deriving its share price. The calculation is based on the zero-growth model, which helps in evaluating the actual share price of the organisation under the relevant assumptions. Bekaert and Hodrick (2017) mentioned that analyst utilise the data for determining the future share price value of the organisation.
The share price is estimated to be at the values of $11.538 after applying the zero-growth model. In addition, the low share price values of the company are estimated due to the assumptions of no growth prospects. Hence, the low growth prospects are reducing the share price values of the organization, as the investors have low confidence on future performance of the company. Furthermore, the share price derived from the valuation is mainly compared with its current share price to determine whether the company is overvalued or undervalued.
|
Constant growth Model |
|
|
Particulars |
Value |
|
Earnings per share |
$ 1.5000 |
|
Expected dividends |
30.000% |
|
ROE |
13.000% |
|
Return to investors |
12.000% |
|
Share price |
$ 50.4000 |
The calculations conducted in the above table depict the share price values that have been estimated under the constant growth model by Analyst B. The analyst has directly assumed that the share price of the organisation will face constant growth in future years. In addition, the expected dividends from the earnings per share price are assumed to be at the level of 30%. In addition, the share price of the organisation is mainly calculated with the help of constant growth model calculation, which values the share price at $50.400. The analyst assumed that the organisation will enter the national market, which will help in generating constant growth rate (Renz 2016).
The share price of the organisation is estimated to be only at the level of $50.40, which is calculated with the help of constant growth model. In addition, the valuation directly indicates that the organisation will project a constant growth rate in its earnings per share, which will increase the dividend payments in the long run. The constant growth rate ensures the investors regarding the prospects of the company, which in turn increases their share price value. The share price under the constant growth rate model is higher than the zero-growth rate model, as the investors can anticipate the future income growth rate of the company.
|
Non-constant Growth Valuation |
|
|
Particulars |
Value |
|
Dividend |
$ 1.50 |
|
Expected dividends |
30% |
|
Growth rate |
20% |
|
Required rate of return |
12.00% |
|
Constant rate |
9.00% |
|
Dividend |
$ 0.45 |
|
Growth |
50.00% |
|
Particulars |
Value |
Dis-rate |
Dis-Value |
|
Dividend 1 |
$ 0.68 |
0.89 |
$ 0.60 |
|
Dividend 2 |
$ 0.81 |
0.80 |
$ 0.65 |
|
Dividend 3 |
$ 0.97 |
0.71 |
$ 0.69 |
|
Share price |
$ 35.32 |
0.71 |
$ 25.14 |
|
Current share price |
$ 27.08 |
The non-constant growth model valuation is mainly depicted in the above table, which is assumed by Analyst C. The calculations conducted in the assessment is mainly based on the non-constant growth valuation has mainly allowed the organisation to generate high level of income from investment. The analyst has assumed that the organisation will enter the national market but expect high level of growth initially and then the growth will be constant thereafter. The share price of the organisation is estimated to be at the levels of $27.08, where growth in dividend is expected to be at the levels of 50% for the first year, while the second-year growth is estimated at 20%. In addition, the constant growth rate from third year is at the levels of 9%.
The analyst uses the non-constant dividend model for detecting the share price level, which is then compared with the current share price to detect whether it is overvalued or undervalued. The share price level of non-constant dividend is lower than constant growth rate, as the anticipation of the share price will alter over the period. Barr and McClellan (2018) mentioned that analyst utilises the growth rate to determine the accurate level of stock price, which can help in making adequate investment decision.
The growth rate in dividends is considered to be the most viable feature, which is affecting the share price valuation of the organisation. In addition, the assumption made by the analyst regarding the growth on the dividends declared by the organisation is shaping its overall share price estimation. This estimation is used for detecting whether the company’s overall the share price is overvalued or undervalued. Hence, from the evaluation it is detected that the share price of the company has changed under all the three-circumstance presented by the analyst. This directly indicates that share price of the organisation is affected by the changing assumptions of growth rate (Marshall 2015).
The analyst can use different model such as FCFF and dividend discount model for deriving the accurate level of share price for the organization. These models require additional information from the annual report of the organization, which is not dependent on the earnings per share and growth rate. Moreover, technical analysis can also be used by the analyst for deriving the actual trend of the shares, which help in making adequate investment decisions. The technical analysis projects the current trend of the company under trend analysis and pattern analysis method.
Investors with the help of risk management are able to mitigate the risk factors in their investment, which allows them to generate higher returns. Moreover, the systematic and unsystematic risk is defined in the risk management, which allows the investors to make adequate investment decisions. Furthermore, the organisation by using the risk management method can eventually reduce the negative impact from the systematic and unsystematic risk. Both the systematic and unsystematic risk is detected by the risk management methods used by the organization. Systematic risk that is identified by the risk management procedures are considered non-controllable, where mitigation strategies cannot reduce its negative impact on the operations of the organization. However, unsystematic risk is controllable in nature, which can be mitigated by using adequate risk management strategies (Valipour et al. 2015).
Unsystematic risk of an organization is adequately divided into operational risk, business risk, and financial risk, which can be mitigated by adopting adequate strategies. Operational risk is classified into political risk, people risk, legal risk, and model risk, which can have negative impact on the operations of the organization. Moreover, the operational risk highlights the risk from the political background, which can hinder the operations of the organization and increase the possibility of its nonexistence. Financial risk is considered the second unsystematic risk, which can deliver negative impact on the operations of the organization (Haque and Nasir 2016). The financial risk is further classified into sovereign risk, settlement risk, exchange rate risk, non-directional risk, recovery rate risk, and credit event risk. However, the financial risk can be mitigated with the help of adequate risk management strategies. The business risk is identified to be unsystematic risk, which is classified into funding liquid risk and asset liquid risk. The identified business risk and directly have negative impact on the operational capability of the company and reduce its capability to continue its operation. In addition, the asset liquid risk increases when the management is unable to generate profit from the sale of their assets, where the organization faces loss due to the loss incurred after selling the asset.
The specific systematic risk is further divided into interest rate risk, market risk and inflationary risk that negatively affects the overall performance of the organization. Moreover, the systematic risk is not mitigated by any risk management strategies that can be deployed by the organization. The further evaluation on the systematic risk directly evaluates the negative impact of the risk can directly affect the operational feasibility of the organization in the long run. The first systematic risk that majorly affects the operational capability of the organization is the interest rate risk. The interest rate risk is further divided into price risk and reinvestment risk, which hinders the capability of the organization to continue its operations smoothly (Jung, Dalbor and Lee 2018). Rising interest rate would reduce the concern of the investors on the share price of the organization, which will negatively affect its capabilities to accumulate adequate finance from the market. Moreover, the rising interest rate would also have negative impact on the reinvestment rate that can be conducted by the organization. The organization reinvests the declared dividend in the organization, where it cannot provide the same returns due to higher interest rate.
Inflation risk is the second major component of the systematic risk that increases the concern for the organization. Inflation risk is further divided into cost inflation risk and demand inflation, which increase the problems for the organization. The increment in cost inflation risk directly raises the level of Expenses that is conducted by the organization to complete its production process. The increment in the expenses of the organization, while the sales remain same will have negative affect in its revenue generation capability. Moreover, the demand inflation risk is most problematic for the management, as the specific risk occurs when the organization is not able to supply in accordance with the rising demand from customer. This risk paves the way for competition, which can decrease market share of the organization by not delivering the required product to the customers. Hence, the demand inflation risk will directly affect the customer base of the organization (Abdoh and Varela 2017).
The third most complex component of the systematic risk is market risk that increases the problems of the organization at market level. The major components of the market risk are relative risk, directional risk, absolute risk, non-directional risk, volatile risk and basic risk. The identified risk direct impact on share price of the business, where the changes in market volatility have higher risk attributes on the organization. Therefore, the market risk negatively affects share price value of the organization by negatively affecting its market capitalization.
There is specific systematic and unsystematic risk that is affecting the investment strategy of the organization. Moreover, identified risk can be mitigated with adequate investment strategies, which reduces the negative impact of the unsystematic risk. The use of adequate diversification methods would eventually help the organization to minimize the negative impact of the capital market on created portfolio. The diversification process of the portfolio would eventually mitigate investments in different sectors and organizations, which will substantially reduce the negative impact on the investment capital (Haque and Nasir 2016). Furthermore, Investments in cash, stock and Bond would eventually reduce the risk attributes of the portfolio and allow the company to generate high level of returns from investment. Moreover, the organization can also use different hedging measures for reducing the negative impact on the created portfolio. Hedging instruments such as option contract and future contracts can be used by the organization for reducing the level of risk involved with the investment. Therefore, the organization can adequately mitigate the risk involved in investment by utilizing the diversification and hedging process.
References:
Abdoh, H. and Varela, O., 2017. Product market competition, idiosyncratic and systematic volatility. Journal of Corporate Finance, 43, pp.500-513.
Barr, M.J. and McClellan, G.S., 2018. Budgets and financial management in higher education. John Wiley & Sons.
Bekaert, G. and Hodrick, R., 2017. International financial management. Cambridge University Press.
Haque, A. and Nasir, A., 2016. Systematic and Idiosyncratic Risk Analysis of Banking and Insurance Sector of Pakistan. Abasyn University Journal of Social Sciences, 9(2).
Jung, S., Dalbor, M. and Lee, S., 2018. Internationalization as a determinant of systematic risk: the role of restaurant type. International Journal of Contemporary Hospitality Management, 30(8), pp.2791-2809.
Marshall, C.M., 2015. Isolating the systematic and unsystematic components of a single stock’s (or portfolio’s) standard deviation. Applied Economics, 47(1), pp.1-11.
Renz, D.O., 2016. The Jossey-Bass handbook of nonprofit leadership and management. John Wiley & Sons.
Valipour, M., Amin, V., Kargosha, M. and Akbarpour, K., 2015. Forecasting stock systematic risk using Heuristic Algorithms. Journal of Productivity and development, 1(1), pp.36-41.
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