Valuation of Adelaide Brighton Limited Stock using CAPM and Dividend Discount Model
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This report provides a valuation of Adelaide Brighton Limited stock using the CAPM and two-stage dividend discount model. It also discusses the operations, risks, and return characteristics of the company. The report concludes that the stock is undervalued and recommends purchasing it.
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REPORT1 Contents Introduction...........................................................................................................................2 Overview of company........................................................................................................2 Operations, risks, and return characteristics of company...................................2 Stock Valuation Methods..................................................................................................3 Two-stage Dividend Discount Model........................................................................4 PE Multiple Model............................................................................................................7 Limitations of models.........................................................................................................7 Assumptions in data...........................................................................................................8 Qualitative or practical considerations influencing valuation............................8 Conclusion..............................................................................................................................9 References...........................................................................................................................10
REPORT2
REPORT3 Introduction At the time, while the buyer and seller trade the stocks, then they decide the stock’s value by the price of the stock at the time of trading. The stock’s value is depended on the corporation’s status, involving the management, earning potential in future and capital structure. In the following parts, the stock of Adelaide Brighton Limited is valued by using thecombination of conventional valuation models like CAPM for equity return estimate, two-stage dividend discount model, and multiples-based (P/E) and fundamental research resources. Overview of company Adelaide Brighton Limited is the producer and vendor of cement, products related to cement, olive, premixed materials, aggregates sand and solid product. Adelaide Brighton Limited runs by 2 segments. One is Concrete Products. Other is cement, olive, concrete and aggregates. This has facilities related to manufacturing of Cement in Western and Southern Australia, and industrial olive manufacturing assets in Northern territory, Southern and Western Australia. This corporation provides the concrete brick, block, retaining wall, erosion controlling product, architectural masonry and reconstituted stone veneers by the places in Victoria, Queensland, NSW, Southern Australia and Tasmania. The main end-use marketplaces of the products related to company involve the inhabited structure and non-inhabited structure, manufacturing construction, industrial construction, alumina and manufacturing of steel and mines. Operations, risks, and return characteristics of company Adelaide Brighton Limitedsupplies infrastructure, buildings and resources industry. It has leading position in market. Adelaide Brighton strengthened the energy supply portfolio with making agreement of new contract related to electricity and gas in Southern Australia. The
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REPORT4 company has made a contract with Beach Energy Limited to make supply of gas to the operations of Southern Australia.This acquisition makes completely vertically integrated material related to construction position in high expansion northernQueensland. This may increase the opportunities for the company to enlarge the distribution of cement in market of northernQueensland. Further,Adelaide BrightonLimited continually works on developing and increasing the system of safety and cultural safety (Kubota and Takehara, 2018). It is believed by a company that good planning and preparation would reduce the risk to the protection and health. The risk management strategy is to recognize report and decrease the risks and hazard toalesserpracticallevel.Byfrequentlyassessingtheoperationsandconsidering requirements of all shareholders, it is possible for a company to identify major opportunities to improve and sustain the expansion. Stock Valuation Methods There are various techniques are available for the investors for the valuation of stock of a company. Certain valuation methods are fairly straightforward whenothers are more included and complex. There are two types of methods of valuation. The absolute modelsare useful in finding the intrinsic value and correct value of the investments on the basis of fundamentals. These models of valuation are dividend discount model, residual incomemodel, asset-based model and discounted cash flow model (Haywood, et. al, 2017). On the other hand, the relative valuation modelsrun through making comparison between similar companies. These methods include calculation of multiples andratios, like P/E multiple, and comparing them to the multiples of comparable company. Typically, the relative valuation modelis simpler and faster in calculation, in comparison of absolutevaluationmodel. This is a reason, for which various investors and forecasters start the evaluation with this model (Duarte and Rosa, 2015).
REPORT5 Two-stage Dividend Discount Model The two-stage dividend discount model contains 2 parts. It is assumed by this model that dividends will go through two stages of growth. In first stage, the dividend increases by a constant rate for a time. In next stage, dividend is assumed to increase at different rate for the remainderoflifeofcompany(Bloomberg,2018).InthecontextofAdelaide BrightonLimited, the fair value of stock can be calculated as follows- 1.Calculation of CAPM (Cost of Equity) Risk free rate (5 years Australian government bond yield) 1.53% Market return (ASX200 return)4.04% Beta1.48 0 Ke5.24% 2. Calculation of growth rate- Growth rate for first 5 years Retention ratio*ROE payout ratio73.94% 100% 26%*14.87% 3.88% Growth rate after 5 years It is assumed that the dividend would grow at GDP growth rate prevailing in the country.
REPORT6 The GDP growth rate in Australia is 2%. 3.Calculation of dividend- TwoStageDividenddiscount model YearDividend 00.2034 10.2113 20.2195 30.2280 40.2368 50.2460 60.2509 4.Calculation of PV Calculation of PV yeardividendPVFPV 10.21130.9502110.20 20.21950.9029010.20 30.22800.8579470.20 40.23680.815230.19 50.24600.7746410.19 Total 0.98
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REPORT7 5.CalculationofPVof terminal value Terminal value Dividend(6thyear) ($) 0.25 09 Growth rate2.00% Cost of equity5.24% TV7. 75 PV of TV at 5th year end 6. 00 Valuation of stock- Fair value= Total PV of dividend+ PV of TV at end of 5thyear = 0.98+6 = 6.98 Actual price= 4.31 In this way, stock is undervalued. The decision of purchase should be taken. PE Multiple Model The P/E ratio is a price the investors are paying for 1 dollar of earnings of companyor profit (Ivanovski, Ivanovska and Narasanov, 2015).This ratio is determined by dividing the current
REPORT8 stock price of company by the earnings per share (EPS). In the Adelaide BrightonLimited, the fair value of stock can be calculated as follows- PE multiple- PEratioof competitor 40.83 EPS of company27.14 Fair value11.08 Actual price4.31 UndervaluedBuy Limitations of models There are various limitations of P/E multiple, partially because of rules related to accounting and partially because of inexact estimates the investor conjures out of thin air at the time f making guess of future growth rate. Following are the limitations of this model- 1.P/E ratio becomes lower at the time of high inflation. It is not possible to attain clear picture regarding the stock’s valuation at the time of bearing phase. 2.The company may alter the earning. And, the earnings per share and P/E ratio may be distorted. 3.The P/E ratio does not give the clear picture of upcoming earning’s potential of an entity (de Azevedo, et. al, 2015). Furthermore, the limitation oftwo-stage dividend discount model is that this model is onlyapplicable to mature corporations and stable corporations who have the proven track records to pay out the dividend constantly (Barberis,et. al, 2015)
REPORT9 Assumptions in data The above calculation is based on the two assumptions. The first assumption is a discount rate. The other assumption is cash flows. As for considering the potential shareholders of Adelaide Brighton limited, the cost of equity (Ke) is used as a discount rate, in place of the cost of capital or weighed average cost of capital that accounts for the debt.In CAPM valuation, the amount aboverisk-free rateis determined by beta multiplied by the equity market premium. Here, the risk free rate is assumed as 5 years Australian government bond yield that is 1.53%. In the addition of this, the market return is considered as three years average market return of ASX200 (Almeida, et. al, 2016). Moreover, for the calculation of dividend, the growth rate of first five years is calculated by determining payout ratio (Mwangi, 2017). The payout ratio is calculated by multiplying the retention ratio with ROE. Additionally, for the calculation of growth rate of next five years, it is assumed that the dividend would grow at GDP growth rate prevailing in the country. The GDP growth rate in Australia is 2%. Besides this, in the valuation of stock as per P/E multiple, the P/E ratio of competitor company ‘LafargeHolcim Ltd’is considered that is 40.83. Qualitative or practical considerations influencing valuation All industries have differences in respect of customer basis,market shareamongst entities, industry-wide increase, contest, regulations and the cycles related to business. They are qualitative or practical considerations affecting the valuation. For an example, the manner of assessing growth potential of company is to first evaluate whether the amount of customer in the market would increase. It is critical because without new customer, the corporation has to steal market share to increase.In certain marketplaces, there is negative growth or zero growth, the factor requiring cautious consideration (Campbell, et. al, 2018).
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REPORT10 Conclusion As per the above analysis, it can be concluded that there are various limitations of P/E multiple to measure the valuation of stock but this method is very simple method of the valuation of stock. The decision related to the investment does not make only just basis of P/E multiple. The stock should also be valued as perCAPM for equity return estimate, two- stage dividend discount model. Before the investment, it is required to consider all the basic parametersinrelationtothesemodels.Asdiscussedabove,thestockofAdelaide BrightonLimited is undervalued according to all the methods. It is recommended to take the decision of purchase of stocks.
REPORT11 References Almeida, G.L., Petralia, G., Ferro, M., Ribas, C.A.P.M., Detti, S., Jereczek-Fossa, B.A., Tagliabue, E., Matei, D.V., Coman, I. and De Cobelli, O. (2016) Role of multi-parametric magnetic resonance image and PIRADS score in patients with prostate cancer eligible for active surveillance according PRIAS criteria.Urologia internationalis,96(4), pp.459-469. Barberis, N., Greenwood, R., Jin, L. and Shleifer, A. (2015) X-CAPM: An extrapolative capital asset pricing model.Journal of financial economics,115(1), pp.1-24. Bloomberg(2018)AustralianRates&Bonds.[Online]Availablefrom: https://www.bloomberg.com/markets/rates-bonds/government-bonds/australia[accessedon 16/4/2019] Campbell, J.Y., Giglio, S., Polk, C. and Turley, R. (2018) An intertemporal CAPM with stochastic volatility.Journal of Financial Economics,128(2), pp.207-233. de Azevedo, J.R., Torres, O.J., Beraldi, R.A., Ribas, C.A. and Malafaia, O. (2015) Prognostic evaluation of severe sepsis and septic shock: procalcitonin clearance vs Δ Sequential Organ Failure Assessment.Journal of critical care,30(1), pp.219-e9. Duarte, F. and Rosa, C. (2015)The equity risk premium: a review of models.Oxford: Oxford University press Haywood, K., Lyddiatt, A., Brace-McDonnell, S.J., Staniszewska, S. and Salek, S. (2017) Establishing the values for patient engagement (PE) in health-related quality of life (HRQoL) research: an international, multiple-stakeholder perspective.Quality of Life Research,26(6), pp.1393-1404.
REPORT12 Ivanovski, Z., Ivanovska, N. and Narasanov, Z. (2015) Application of dividend discount model valuation at Macedonian Stock Exchange.UTMS Journal of Economics,6(1), pp.147- 154. Kubota, K. and Takehara, H. (2018) Does the Fama and French Five‐Factor Model Work Well in Japan?.International Review of Finance,18(1), pp.137-146. Mwangi, W.M. (2017) Testing the Gordon’s Growth Model.Research Journal of Finance and Accounting,8.