Investment And Portfolio Management For Financial Position

Discussion

Discuss about the Investment and Portfolio Management for Financial Position.

Portfolio Management is the process of making decision for the purpose of investment in companies’ stocks and shares by the individuals and other institutions to generate maximum return. It represents the art of selecting and investing in the optimum shares of the companies based on the market capitalization, performance of the company, financial position of the company and other related factors (Income 2015). Among all the factors, market capitalization and price earnings ratio are the most significant factor that measures the companies’ efficiency of trading in the stock market. Market capitalization represents the market value of the organization’s outstanding securities that is used to determine the organization’s size and current position in the stock market. However, many a times the market valuation does not represent the accurate and correct value of the company’s shares as the price of the shares are either overvalued or undervalued (Andriosopoulos and Lasfer 2015).

The following assignment presents the analysis on the undervaluation and overvaluation of the company’s shares that is listed on Australian Securities Exchange (ASX) included in the top 200 stocks. The analysis has been conducted by selecting an Australian company Myer Holdings Limited (Schall 2015). Currently the company has reported revenue amounted to AUD 3.3 billion while operating income is AUD 113.5 million during the financial year 2016. The company is engaged in the retailing business of clothing for men, women and children including the accessories, cosmetics, footwear and other electronic and general stuffs. The organization has been reported as the largest departmental store in Australia considering its revenue and count of the store number.

An organization’s share price depends on several factors that determine the company’s efficiency in trading and providing expected returns to the investors. Several methods used to value the securities of the company to determine the overvaluation or undervaluation of the shares in the current market industry. Overvaluation of the stock states the shares are being sold in the stock markets at a price that is higher than its actual intrinsic value. On the other hand, undervaluation of the stocks represents the selling price of the organization’s shares that is essentially below its actual intrinsic value. Factors that are considered to determine the correct valuation of shares are current price of the securities, dividend on each share and earnings per share. On the contrary, valuation of shares is also determined by using the methods of Net Asset, Market Value, Earning Yield, Dividend yield and capacity of earning method (Lauterbach and Pajuste 2015).

As per Net Asset Value Method, Company’s share valuation is determined by dividing the net asset value from the number of company’s shares. Considering the Myer Holdings Limited’s current financial details, net asset of the company is $863 million and total number of outstanding shares is 585.69 million. Therefore, company’s price of share as per the net asset value method is $863 million/585.69 million = $1.47 per share whereas the current trading price of the company’s share is $1.22. Hence it can be said that the stock of Myer Holdings Limited is underpriced as per the method of Net Asset value. Accordingly, investors are recommended to go long on the securities of the company. It can be interpreted from the valuation of shares through net asset value method that the intrinsic value of the Myer’s share is higher than the actual trading price. So, the investors have good acquisition target for the company’s securities because the price of the shares may rise in near future by providing the good rate of return (Duke, Nneji and Nkamare 2015).

Valuation of shares can also be determined by using the market value method or yield value method which denotes the expected return of the individual or institutional investors. Rate of return is a return that the investors earn on the amount of their investment that may be in terms of either earning yield or in terms of dividend yield. According to the earning yield method, the valuation of shares is determined by considering the expected return and normal prevailing return rate (Amanatidis et al. 2015). It is determined by using the formula as follows: (expected rate of return/normal rate of return) * paid up equity securities value. Where, expected rate of return is determined as (profit after tax/ paid up equity securities value) * 100. As per the financial information of Myer Holdings Limited, earnings yield is 6.31% assuming the standard normal rate of return is 8% in the current market scenario while the paid up value of the shares is $524.75 million. Therefore, the valuation of share is 6.31% / 8.00% * $524.75 million = $413 million i.e. $0.71 per share which is less than the actual price $1.22. Hence, the equity securities of Myer Holdings Limited is said to be overpriced and investors are recommended to go short on the company’s shares investment (Duke, Nneji and Nkamare 2015).

On the other hand, dividend yield valuation method is used to determine the value of shares by using the expected rate of dividend and normal rate of return. The valuation of shares is measured by (expected rate of dividend/normal rate of return) * paid up equity securities value. Where, expected rate of return is determined as (profit for dividend/ paid up equity securities value) * 100. According to the current market data of Myer Holdings Limited, dividend yield of the company is 4.10% and the standard rate of return as per the assumption is 8.00%. Therefore, the value of shares is 4.10/ 8.00 * $524.75 million = $268.94 million i.e. $0.50 per share. Since the actual price is higher than the intrinsic value of shares as per dividend yield, the value of the shares can be said to be overpriced (Kokkonen and Suominen 2015). Hence, it is recommended to the individual and institutional investors to go short on company’s market share.

Other methods for valuation of shares include the method of earning capacity that determines the overvaluation or undervaluation of shares in current market structure. It is measured by considering the total profit attributable to the investors, which is calculated by deducting the tax expenses and amount transferred in the reserves from the net profit earned by the organization (Liu and Swanson 2016). In order to measure the value of shares through this method, capitalized value is required to be determined by the following way: (profit available to attribute to the shareholders/ normal rate of return) * 100 i.e. $29.826 million/8.00% * 100 = $372.82 million. Therefore value of each share is capitalized value/ total number of outstanding shares i.e. $372.82 million/ 585.68 million = $0.64. Since the actual price of the company’s share is $1.22, the shares are said to be overvalued (Moolman and Du Toit 2015).

Other than those methods over valuation and under valuation of Myer Holding Limited’s share depends on other factors PE ratio, market capitalized value relative to the GDP ratio of the industry. Considering the current market details of Myer Limited, PE ratio of the company is 15.84 while the standard PE ratio of the industries is 15.00. Since the company’s PE ratio is higher than the standard industrial PE ratio, it can be said that the shares of Myer Holdings Limited is overvalued (Jensen, Quinn and Weymouth 2015). It can be interpreted from the analysis that the overvaluation of the company’s securities represents the fall in price of the shares in near future therefore it is not considered to be good acquisition target. Further, if the PE ratio of the company to the EPS growth is less than one then the company’s share are said to be undervalued. On the contrary, if the PE ratio to EPS growth is higher than one then the securities or stocks of the company are said to be overvalued. As per the financial details PE ratio of Myer Limited is 15.84 and EPS is $0.077 i.e. EPS growth is 7.7% therefore, the ratio between PE ratio and EPS growth is 15.84/7.7 = 2.05 that is higher than one. Hence the actual price of the company’s share is overvalued and the investors are recommended to go short on acquisition of the Myer’s equity stocks (Hossain and Ahmad 2015).

For the purpose of determining the valuation of shares of a company, it is essential to consider other factors that influence the price of the equity stocks. Such factors are market interest rate, trend of the overall stock exchange market, market capitalization value including the political and legal factors. Further, if valuation of shares is determined by net asset method the value of assets is measured by including goodwill, bad debt provision, any unrecorded asset whereas fictitious assets are required to be deducted (Goh et al. 2015). Accordingly, in case of Myer Holdings Limited, valuation of shares has been determined by considering all the sources that influence the over or under valuation of the shares in the present market trade. However, price earnings ratio is considered to be one of the important factors to determine the over valuation or under valuation of the shares for investment purpose. The current trading price of the share of Myer Holdings Limited is $1.22 while the PE ratio of the company is 15.84, therefore it can be interpreted that the stock of Myer Ltd is trading fifteen times its earnings. Hence, the shares of Myer Holdings Limited is said to be overvalued in the present market scenario (Cziraki, Lyandres and Michaely 2016).

Methods that are used to measure the value of shares, used to determine the theoretical values of the organizational securities. It assists in determining the potential trading price or market value of the securities to fetch maximum return on the amount of investment. In case the shares of the companies are undervalued compared to the theoretical or intrinsic value, then the shares are recommended to be acquired. On the contrary, if the securities of the companies are overvalued then the same shall be advised to be sold (Seguin 2016). However, the over valuation and undervaluation of the securities depend on the sources and methods used to compute the fair price of the shares. Shares of Myer Holdings Limited are currently trading at $1.22 whereas the price earnings ratio 15.84, EPS is 0.077 and dividend yield is 4.10%. If the fair value or theoretical value is determined by considering PE ratio then it can be said that the securities of Myer is overvalued and investors should go short on the shares of the company. But if the theoretical value of the company is measured by asset- backing approach or net asset value method then it has been noticed that the Myer’s securities are undervalued. Therefore the investors are recommended to go long i.e. buy the securities. Further, if the dividend yield of Myer Limited is considered it can be noted that the shares of the company $1.22 overvalued and the investors are recommended to go short on the shares of the entity. Moreover earning per share of Myer Holdings Limited is $0.077 which states that the company has the efficiency to provide $0.77 return on each share acquired by the investors. Since the trading price of the company at current date is $1.22, it can be interpreted that the investors would earn the return of $0.077 per share on the investment of $1.22 per share (Saunders and Brynjolfsson 2016).

Valuation of shares is a fundamental analysis to determine the intrinsic value or fair value of the entity’s shares based on the earning capacity, financial performance, potential cash flows and other legal factors. For instance, if a company’s dividend payout ratio is high and the retention ratio is low then the company is said to be inefficient in investment strategy and therefore investors may not be willing to acquire the stocks. Myer Holdings Limited has earnings yield at the rate of 6.31% whereas dividend yield is 4.10% which means that the company’s retention ratio is 2.21%. It can be said that company has efficient investment strategy as well as the distribution of income hence; the investors can acquire the securities of the company in view of its potential growth (Damodaran 2016). The over or under valuation of the securities of the company can also be determined by using the method of discounted cash flow that is expected to be earned by the investors from investment in future. However, in case of Myer Holdings Limited it is difficult to ascertain the future cash flows therefore the intrinsic value of the securities through discounted cash flow method cannot be ascertained. Therefore, as the main component to measure the fair value of the stocks is price earnings ratio, over valuation or under valuation of Myer Holdings Limited’s stocks is considered on the basis of PE ratio. From the above discussion it has been interpreted that the stocks of Myer Limited are overvalued therefore investors should go short on the company’s securities (Cornell 2015).      

Conclusion

Decision of investment in a company’s shares depends on the several factors primary of which is the fair value of the securities in the current market trend. As discussed above, it is important to determine the correct valuation of securities trading on the stock exchange with respect to the company’s financial performance and financial position. If the securities are found to be overvalued then the investors should sell the securities while if the securities are undervalued then the investors are required to acquire the company stocks. However, the most important factor to measure the fair value or theoretical value of the securities is the price earnings ratio of the company and the value of net asset value. Considering the price earnings ratio of Myer Holdings Limited, the stocks at current market is overpriced therefore it is recommended to go short on the company’s investment. On the other hand, if the net asset value method is considered for the securities of Myer Holdings Limited then the value of the securities has been determined as undervalued with respect to the theoretical value. Hence, the investors of are recommended to go long on the shares of the company. Moreover, the fair value of shares of the company also depends on the earnings growth as well the dividend yield for the current year as well as for the past years. For the purpose of fair valuation of the shares, market capitalization value also plays an important role since it determines the value of the enterprise. Considering the market cap of Myer Limited value of shares can be said to be overvalued. In view of the earning yield as well as the dividend yield of Myer Limited in the current market trend, stocks of the company are overvalued since the dividend yield and earning yield are higher than the standard industrial rate. Similarly, if the earning per share of the company is taken into account for measuring the correct valuation of shares, it can be concluded that the shares are overpriced. Hence considering the main valuation factors of share valuation it is to be concluded that the shares of Myer Holding Limited are overvalued.    

Reference List

Amanatidis, G., Markakis, E., Nikzad, A. and Saberi, A., 2015, July. Approximation algorithms for computing maximin share allocations. InInternational Colloquium on Automata, Languages, and Programming (pp. 39-51). Springer Berlin Heidelberg.

Andriosopoulos, D. and Lasfer, M., 2015. The market valuation of share repurchases in Europe. Journal of Banking & Finance, 55, pp.327-339.

Cornell, B., 2015. Using Dividend Discount Models to Estimate Expected Returns. The Journal of Investing, 24(1), pp.48-51.

Cziraki, P., Lyandres, E. and Michaely, R., 2016. What Do Insiders Know? Evidence from Insider Trading Around Share Repurchases and SEOs.Evidence from Insider Trading Around Share Repurchases and SEOs (February 15, 2016).

Damodaran, A., 2016. Damodaran on valuation: security analysis for investment and corporate finance (Vol. 324). John Wiley & Sons.

Dudney, D.M., Jirasakuldech, B., Zorn, T. and Emekter, R., 2015. Do residual earnings price ratios explain cross-sectional variations in stock returns?. Managerial Finance, 41(7), pp.692-713.

Duke, S.B., Nneji, I.D. and Nkamare, S.E., 2015. Impact of Dividend Policy on Share Price Valuation in Nigerian Banks. Archives of Business Research,3(1).

Goh, B.W., Li, D., Ng, J. and Yong, K.O., 2015. Market pricing of banks’ fair value assets reported under SFAS 157 since the 2008 financial crisis.Journal of Accounting and Public Policy, 34(2), pp.129-145.

Hossain, M. and Ahmad, A., 2015. Is Buying Back of Shares a Dangerous Financial Strategy?. Global Journal of Management And Business Research,15(7).

Income, I., 2015. Dividend Income. Personal Finance: An Encyclopedia of Modern Money Management: An Encyclopedia of Modern Money Management, p.98.

Jensen, J.B., Quinn, D.P. and Weymouth, S., 2015. The influence of firm global supply chains and foreign currency undervaluations on US trade disputes. International Organization, 69(04), pp.913-947.

Kokkonen, J. and Suominen, M., 2015. Hedge funds and stock market efficiency. Management Science, 61(12), pp.2890-2904.

Lauterbach, B. and Pajuste, A., 2015. The long-term valuation effects of voluntary dual class share unifications. Journal of Corporate Finance, 31, pp.171-185.

Liu, H. and Swanson, E.P., 2016. Is price support a motive for increasing share repurchases?. Journal of Corporate Finance, 38, pp.77-91.

Luo, Y., Ren, J. and Wang, Y., 2015. Misvaluation comovement, market efficiency and the cross-section of stock returns: Evidence from China.Economic Systems, 39(3), pp.390-412.

Moolman, E. and Du Toit, C., 2015. An econometric model of the South African stock market. South African Journal of Economic and Management Sciences, 8(1), pp.77-91.

Saunders, A. and Brynjolfsson, E., 2016. Valuing Information Technology Related Intangible Assets. Mis Quarterly, 40(1), pp.83-110.

Schall, L.D., 2015. Valuation of an Equity Interest. Review of Pacific Basin Financial Markets and Policies, 18(04), p.1550021.

Seguin, P.J., 2016. The Relative Value of Public Non-Listed REITs. Journal of Real Estate Research, 38(1), pp.59-92.

Vernazza, C.R., Wildman, J.R., Steele, J.G., Whitworth, J.M., Walls, A.W., Perry, R., Matthews, R., Hahn, P. and Donaldson, C., 2015. Factors affecting patient valuations of caries prevention: Using and validating the willingness to pay method. Journal of dentistry, 43(8), pp.981-988.