This report emphasizes on different practical concepts related to finance such as calculation of beta by the help of historical data related to share price in All Ordinaries share index and share prices of the company. Besides this, the estimated beta is being compared with the published data in order to find out the difference and the reason behind it. Apart from this, required rate of return is also being calculated by the use of CAPM model along with this the dividend and current share price is also being calculated by the use of different discount models in order to find out its impact on the stock valuation. Besides this, there is also an evaluation of different factors and variables that have been considered and influence the stock valuation. For this purpose, Beacon Lighting Group, a retail company listed on ASX is being selected.
Beacon Lighting Group is considered as the leading specialist retailer of Australia established in the year 1967 in Melbourne. Besides this, it specialized in lighting products with the presence of extensive product knowledge and renowned customer service which in turn makes it one stop shop for all lighting needs of the customers. It is a leading specialist in ceiling fans, light globes and lightings. It encompasses fashion and design elements and trying to integrate latest technologies for energy efficient products (Beacon Lighting, 2018). It also provides in home lighting design service to its customers by the way of sending a consultant to the premises of the customer which helps in making a plan for designing a perfect lighting at free cost.
The network of the group consists of 106 stores across each of the state in Australia and Territory with four commercial sales offices. The company has also adopted green lighting technologies and designs to provide specialized advice to the customers in an effective and efficient manner (Beacon Lighting, 2018). The company is also member of Lighting Council Australia which encourages it to manufacture high quality lighting systems and components to meet the need of commercial, industrial and outdoor sectors. In year 2017 the company has completed 50 years of living and its 100th store was opened.
Beta is considered as the systematic risk faced by the company. For the computation of the Beta there is a requirement of estimating the return on the security and the market index by consideration he historical share prices for both market index and security over a period of time there might be a possibility that the time period and interval may vary. The returns have been measured on weekly, monthly or daily basis (Menkveld, 2013). There might be a possibility that different agencies use different methods for calculation of the beta such as total return or dividend yield + capital gain i.e. return on share and market index (Damodaran, 2012). Besides this, the agency may also use capital gain or loss or price returns for the estimation of the beta of a company’s share.
Value of beta = COVARIANCE (Share’s Daily % change, % change of Index on daily basis) / VAR (% change of Index on daily basis)
COVARIANCE (Share’s Daily % change, % change of Index on daily basis) = 1.09549E-05
VAR (% change of Index on daily basis) = 6.11061E-05
Value of beta = 0.179276957
The estimated beta of Beacon lighting Group is 0.1792 whereas the value of the published beta estimated by Reuters for the company is 0.62 (REUTERS, 2018). It is found out that there is a presence of occurrence of difference in the values calculated by the use of total return method and the published beta on Reuters i.e. 0.1792 and 0.62 respectively.
The different reasons behind the existence of the difference between the estimated and published beta is that the presence and consideration of different indices used by the agencies for the calculation of the beta (Damodaran, 2012). Along with this, the other reason is that there might be a difference of the time interval considered to calculate the beta such as number of years considered, monthly, daily or annual share prices. Apart from this, it is also possible that Reuters has used different methods for the estimation of the beta this results in bringing variations in the beta values there is a presence of different determinants that influences beta such as nature of the business, operating leverage and financial leverage (REUTERS, 2018). There might be a possibility that there is an occurrence of frequent fluctuations in the earning s of the company with the business cycle which results in bringing variability in the earning. In addition to this, increased variability in the fixed cost results in the occurrence of increased variability in EBIT for a particular change in sales and intensifies the effect of cyclicality on the earnings of the company (Damodaran, 2012).
CAPM model reflects the determination of return on an asset by establishing the relationship between return and risk of an asset. This rate of return helps in the valuation of the assets and comparing the estimated rate of return with the required rate of return in order to determine that the assets is fairly valued. The relationship between the required rate of return and risk of an asset is determined by the use of security market line. There are different assumptions that are considered while using this model for the determination of the required rate of return of assets such as risk aversion and mean variance optimisation, single time period, market efficiency, risk free rate and homogeneous expectations (Kisman, and Shintabelle Restiyanita, 2015).
It is assumed that the share prices reflect all the available information and individual investors does not have a significant impact on the prices of the security. it is also assumed that investors are considered as risk averse and calculate the expected return by the use of variance and standard deviation which reflects that they are able to form efficient portfolio apart from this it is found out that all the investors have same expectations related to risk and return of the securities and their decisions are based on single time period (Chrysafis, 2012). It is also assumed that the investors lend and borrow money at risk free rate of interest in order to form portfolios form publically traded securities such as bonds and shares.
The required rate of return calculated for Beacon lighting group can be calculated by the use of CAPM model in a following manner.
Expected return = Rf + β (Rm – Rf)
Here, β = beta of the security (0.62)
Rf = Risk free rate (2.67%)
Rm = Market return (6.5%)
Expected return = 2.67 + 0.62*(6.5-2.67)
= 2.67 +0.62*3.83
= 2.67 + 2.37 = 5.04%
The dividend discount model helps in the determination of the price of the stock through discounting the expected dividends to a present value. it is based on the idea that the estimation of the intrinsic value of stock is considered by expected value of cash flows that are being generated in the future by the company. the main premises of the model is consideration of the net present value of the cash flows by considering the concept of the time value of money this model cannot be applied to the companies that do not believe in the dividends to its shareholders. The main reason behind it is that it considers discount rate, dividend per share and expected rate of dividend growth (Irons, 2014). This model is also known as Gordon growth model. It is also found out that if the value of current price of the share estimated by the use of dividend discount model is higher than the current market price of the share then it is identified that the stock is undervalued (Burns, and Dewhurst, 2016).
The assumptions and relevance of Gordon Growth model includes different factors such as constant cost of capital, perpetual earnings, constant retentions, higher cost of capital in comparison to growth rate, no taxes, no external financing, constant return and all equity firm. It is identified that the company does not use external sources of finance for the purpose of expansion of business and only rely on the retained earnings (Burns, and Dewhurst, 2016). Apart from this, the company does not rely on debts for the purpose of financing of its operations. Along with this, the internal rate of return of the firm is constant and does not take into consideration the diminishing marginal efficiency of the investment. This model also ignores the effect of change in the risk class of the firm and its impact on discount rate. It also does not consider the involvement of corporate taxes. The retention ration is also constant due to which the growth rate is considered stable forever (Irons, 2014). It is also found out that the discount rate should not be equal to growth rate and should be greater than this in order to reach to a meaningful value of the share.
In context of Beacon Lighting Group, the current price of the share is being estimated by the use of Gordon Growth Model through the following equations.
Price per share = D1/(r-g)
D1 = estimated value of the dividend in next year [D1 = D0 x (1 + g)].
g = constant growth rate
r = cost of company’s equity capital
D0 = Current year dividend
D1 = D0 x (1 + g)
= 0.03* (1+0.04) = 0.03*1.04 = 0.0312
Current price per share = 0.0312/ (0.0504 – 0.04) = 0.0312/0.0104 = 3.00
Inflation refers to the phenomena in which increase in the level of employment in the country results in increase in the level of prices of the goods and services in a gradual manner. It also results in decline in the purchasing power of the consumer in a consequent manner. This is an important factor that affects the economy and is tried to control by the central bank. Rising inflation has dangerous impact due to increase in input prices, revenues and profits declines and economy slow for a time till steady state occurs (Gallo, Hann, and Li, 2016).
Analysing the historic data relating to the returns of the stock holdings, high or low inflation indicates some clarity for the investors. But there are conflicting outcomes and most of the study depicts that the positive or negative impact on the stock depends upon the investor’s ability to hedge and the policy of the government or monitory policy (Pinto, Henry, Robinson, and Stowe, 2015). It is also identified that the returns on the stocks in the developed markets are stable where as there is more fluctuation in the returns of the stock in developing countries. The inflation rate between 2-3% is good signal and the stock provides highest returns in this situation where as in case of less or more inflation rate the returns are negatively affected (RBA, 2018).
It is identified that Beacon lighting group is listed on ASX in year 2014 due to which the required rate of return on stock at the growth rate of 4% would remain same at $3 (Beacon Lighting, 2018). The current inflation rate is around 2% which would result in an increase in growth rate of dividend to 6% and has a significant impact on current stock price of the company. This has been calculated as follows.
Price per share = D1/(r-g)
D1 = estimated value of the dividend in next year [D1 = D0 x (1 + g)].
g = constant growth rate
r = cost of company’s equity capital
D0 = Current year dividend
D1 = D0 x (1 + g)
= 0.03* (1+0.06) = 0.03*1.06 = 0.0318
Current price per share = 0.0318/ (0.0504 – 0.06) = 0.0318/-0.0096 = 3.3125.
The increase in the inflation rate results in declining of the purchasing power of customer. In the given scenario there is an existence of decline in the inflation rate which makes the stock attractive to the investors due to payment of the dividend. Increase in the purchasing power of the customers during low inflation has a positive impact on the taxation on dividends as dividend yielding stocks provide partial hedge over inflation (RBA, 2018). Decline in the inflation rate results to increase in the prices of stock this shows that there is a negative relationship between incomes generated stocks and inflation. In this case also the estimated current price per share of Beacon lighting group has also increased to $3.3125 from $3. This induces the investors to sell the stock during the time of declined inflation rate (Gay, 2016).
The different factors or variables that are considered while making the change in the CAPM and Dividend Discount Models for the determination of the current stock price close to its fair value is as follows:
Changes in beta: The value of the beta in CAPM model helps in the determination of the movement in the asset in relation to movement in market portfolio (Damodaran, 2012). It is difficult to estimate the value of the beta over a period of time but in case there would be a use of the beta calculated by the use of total return method and its value is 0.1828.
Changes in market risk premium: It is found out that earlier, there is a use of the market risk premium that has considered the imputation of the tax that has resulted in an increase in the market risk premium but now the stock prices of all ordinary indexes have been used to calculate the market risk premium which is 0.00016 (Chrysafis, 2012).
Thus, the required rate of return for the security of Beacon Lighting Group as per CAPM is as follows:
Expected return = Rf + β (Rm – Rf)
Here, β = beta of the security (0.1792)
Rf = Risk free rate (2.67%)
Rm = Market return (0.00016)
Expected return = 0.0267 + 0.1792 *(0.00016-0.0267) = 0.0267 + 0.1792 *-0.02654
= 0.0267 – 0.004755 = 0.0219 = 2.19%
Apart from this, it is also estimated that the growth rate of dividend is assumed as 3% which reflects that the dividend to be paid out in next year would be D1 = estimated value of the dividend in next year [D1 = D0 x (1 + g)].
g = constant growth rate
r = cost of company’s equity capital
D0 = Current year dividend
So the dividend of next year = 0.03 * (1+0.03) = 0.0309
r = 5.04%
g = 2%
Thus the current share price can be calculated as follows:
Price per share = D1/(r-g)
= 0.0309 / (0.0504 – 0.03) = 0.0309 / 0.0204 = $1.51
This indicates that the price of the share is close to the current market price equal to $1.55. The main reason behind it is that the dividend growth rate is adjusted to the change in the inflation rate of 1.81%.
There are mainly three types of methods which are used for the valuing of the stock such as discounted cash flow method, cost method and the comparable approach. The comparable approach is considered as a relative valuation approach and the basic assumption of the comparable approach is that the value of the equity is required to be resembled with other equities in the market (Grant, 2016). This can be computed by making comparison to the key competitors that operates in similar businesses. The presence of discrepancies in the value similar to firms helps in providing opportunity to the company which means that the value of the equity is undervalued and can be brought until there is an increase in the value of the stock. Apart from this, the occurrence of the value of the equity as overvalued may present the opportunity for shorting of the stock and positioned it due to decline in its price. There is an existence of two primary comparable approaches that are used by the investors to make comparison of the value of stock of two or more firms (Ehrhardt, and Brigham, 2016). The first approach takes into consideration different market multiples like enterprise-value-to-sales, price to earnings, price to book, price to free cash flow and enterprise multiple. The other comparable approach emphasises on the market transactions in which emphasis is given on similar firms, smaller divisions that are acquired by the rivals and private equity firms. This helps in providing reasonable estimate of the value for a firm (Hand, Coyne, Green, and Zhang, 2017). It is also found out that it is very difficult to compare the companies and transactions to value equity. It is considered as a challenging task. Besides this, the use of trailing and forward multiples also make a huge deviation in the analysis in a way that if there is an existence of growth in a company then the historical valuation is not considered as accurate and there is a need to make a reasonable estimate of future market multiples. This method provides a realistic comparison of the valuation of the equity of a firm with its competitors. As the name suggests comparable approach, in context of Beacon Lighting Group, the comparison is made with the firms dealing in same sector or industry in order to analyse the position of the company and its valuation.
Figure 1: Share price comparison (Source: ASX, 2018)
At the first instance there is comparison that is made is on the basis of the prices of the shares and its 52 weeks high low leads to decide the current position of the company. While evaluating the share price of the Beacon lighting Group (BLX) and its competitors are needed to be identified. The major competitors as per the available information on Australian Stock exchange were Michael Hill International Ltd., Noni B ltd., Audio pixels holdings limited and PWR holdings Ltd (ASX, 2018). The share price of the Michael Hills International Ltd (MHJ) is $0.92 and 52week high is $1.34 and low of $0.79. Similarly, the share price of Noni B Ltd. (NBL) is $3.51 and has reached a high of $3.70 and low point to $1.75 in past 1 year (REUTERS, 2018). In addition to this, Audio Pixels holdings ltd (AKP) is having share price of $12 and a high of $26.09 and low in 52 week is $11.38.
From the basis analysis of share price of BLX is 1.56 and it is having a 52 week high of 1.79 and low of $1.34 (REUTERS, 2018). It is analysed that AKP is the share which can be considered for the investment decision as it is near to its low and will provide better returns in long term investments.
Enterprise value (EV) is also a measure for the value of the company it is more comprehensive and considered as alternative to equity market capitalization. It can be obtained by the help of market capitalization, debt, preferred shares and interest less total cash and cash equivalents.
Enterprise value = Market capitalization + MV of preferred equity + MV of debt + minority interest – cash and Investments.
EV of BLX = $336.60m + 0 + ($9.321m+$23.928) + 0 – $12.925 = 356.924
EV of MHJ = $356.44m + 0 + ($107.286) + 0 – 238.581 = 225.145
EV of NBL = $333.32 + 0 + (47.566 + 2.729) + 0 – 61.722 = 321.893
EV of AKP = 601.61 + 0 + (6.388) + 0 – 2.700 = 605.298
Enterprise to revenue of the companies can be determined as below
= Enterprise value/Revenue
BLX = 356.924/217.372 = 1.641 (Beacon Lighting Group Limited, 2017).
MHJ = 225.145/582.975 = 0.3862 (Michael hill International Limited, 2017).
NBL = 321.893/311.483 = 1.033 (NONI B Group, 2017).
AKP = 605.298/0.065 = 9312.276 (Audiopixels, 2017).
This indicates that the MHJ is having the most suitable enterprise to revenue ratio depicting the as the most appropriate company for the purpose of measuring the company value. The gross margins and operating margins of the companies that are compared as below:
|
Company |
Share price |
Enterprise value |
Revenue |
EPS |
EV/Revenue |
Price/Earnings |
Gross margin |
Operating margin |
|
BLX |
1.56 |
356.924 |
217.372 |
0.09 |
1.641 |
17.8 |
63.77 |
11.27 |
|
MHJ |
0.92 |
225.145 |
582.975 |
0.09 |
0.3862 |
10.24 |
63.75 |
8.62 |
|
NBL |
3.51 |
321.893 |
311.483 |
0.21 |
1.033 |
16.18 |
64.86 |
7.12 |
|
AKP |
12 |
605.298 |
0.065 |
-0.17 |
9312.276 |
Nil |
– |
-5557.4 |
The next indicator for the purpose of comparison of the firms is earning per share, it is an approach that evaluates the companies on the basis of the Earnings per share. It is the part of the company’s profit that is allocated to each share that is being issues in the stock market (REUTERS, 2018). The information available at the Reuters indicates that the Earning per share of the BLX is 0.09 and the P/E ratio of the company is 17.8% at the same time the EPS of the other competitors are the P/E ratio of MHJ is 10.24 and the EPS is 0.09 (REUTERS, 2018). The EPS of NBL is 0.21 and the P/E ratio is 16.18. The price to earnings ratio of AKP is not available since the company is operating in loss therefore it is having a negative EPS of 0.17 (REUTERS, 2018).
Conclusion
It can be concluded that it is significant to evaluate the various factors that are associated with the valuation of the securities in a capital market. Beacon Lighting is offering diverse product range to provide lighting solutions. The calculation of the bets has resulted to a beta value of 0.182 depicting very less volatility of the share prices with the change in the index. The beta values available at the published data is different indicating the difference in the time period of evaluation and factors that are considered for evaluation such as daily, monthly process. In addition to this, CAPM model is also used to identify the relation among the risk and return in an asset. The expected return identified for the Beacon lighting is 5.04% and share price identified with the help of dividend discount model is $3.00. At the same time, while considering the inflation at 2% in this period will lead the share price of $3.312. The comparison of the value of stock was done through the enterprise value, price to earnings, earning per share and other methods that helps to identify the reasonable estimate.
References
ASX (2018). BLX: Sector comparison. Retrieved from: https://www.asx.com.au/asx/share-price-research/company/BLX
Audiopixels (2017). 2017 Annual report. Retrieved from: https://www.audiopixels.com.au/investor/annual-report/
Beacon Lighting Group Limited (2017). ANNUAL REPORT 2017. Retrieved from: https://www.beaconlightinggroup.com.au/media/pdfwidget/BLX-2017-Annual-Report.pdf
Beacon Lighting, (2018). ABOUT US. Retrieved from: https://www.beaconlightinggroup.com.au/about-us
Burns, P., & Dewhurst, J. (2016). Small business and entrepreneurship. USA: Macmillan International Higher Education.
Chrysafis, K. A. (2012). Corporate investment appraisal with possibilistic CAPM. Mathematical and Computer Modelling, 55(3-4), 1041-1050.
Damodaran, A. (2012). Investment valuation: Tools and techniques for determining the value of any asset (Vol. 666). USA: John Wiley & Sons.
Ehrhardt, M. C., & Brigham, E. F. (2016). Corporate finance: A focused approach. USA: Cengage learning.
Gallo, L. A., Hann, R. N., & Li, C. (2016). Aggregate earnings surprises, monetary policy, and stock returns. Journal of Accounting and Economics, 62(1), 103-120.
Gay, R. D. (2016). Effect of macroeconomic variables on stock market returns for four emerging economies: Brazil, Russia, India, and China. The International Business & Economics Research Journal (Online), 15(3), 119.
Grant, R. M. (2016). Contemporary strategy analysis: Text and cases edition. USA: John Wiley & Sons.
Hand, J. R., Coyne, J. G., Green, J. R., & Zhang, X. F. (2017). The use of residual income valuation methods by US sell-side equity analysts. Journal of Financial Reporting, 2(1), 1-29.
Irons, R. (2014). Enhancing the dividend discount model to account for accelerated share price growth. Journal of Accounting and Finance, 14(4), 153.
Kisman, Z., & Shintabelle Restiyanita, M. (2015). The Validity of Capital Asset Pricing Model (CAPM) and Arbitrage Pricing Theory (APT) in Predicting the Return of Stocks in Indonesia Stock Exchange. American Journal of Economics, Finance and Management Vol, 1, 184-189.
Menkveld, A. J. (2013). High frequency trading and the new market makers. Journal of Financial Markets, 16(4), 712-740.
Michael hill International Limited (2017). ANNUAL REPORT 2017. Retrieved from: https://investor.michaelhill.com/static-files/97f78116-fe10-49b6-8512-d45a1725d667
NONI B Group (2017). Annual Report 2017. Retrieved from: https://www.nonib.com.au/2017-annual-report
Pinto, J. E., Henry, E., Robinson, T. R., & Stowe, J. D. (2015). Equity asset valuation. John Wiley & Sons.
RBA (2018). Inflation. Retrieved from: https://www.rba.gov.au/publications/smp/2018/may/inflation.html
REUTERS (2018). Audio Pixels Holdings Ltd (AKP.AX). Retrieved from: https://www.reuters.com/finance/stocks/overview/AKP.AX
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