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Valuation of Adelaide Brighton Limited Stock using CAPM and Dividend Discount Model

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Added on  2023/01/19

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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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Running head: REPORT 0
Financial Strategy & Governance
APRIL 16, 2019
STUDENT DETAILS:

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REPORT 1
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
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REPORT 2
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REPORT 3
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
the combination 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 Limited supplies 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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REPORT 4
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 northern Queensland. This may
increase the opportunities for the company to enlarge the distribution of cement in market of
northern Queensland.
Further, Adelaide Brighton Limited 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
to a lesser practical level. By frequently assessing the operations and considering
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 when others are more included
and complex. There are two types of methods of valuation. The absolute models are 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 income model, asset-based
model and discounted cash flow model (Haywood, et. al, 2017). On the other hand, the
relative valuation models run through making comparison between similar companies. These
methods include calculation of multiples and ratios, like P/E multiple, and comparing them to
the multiples of comparable company. Typically, the relative valuation model is simpler and
faster in calculation, in comparison of absolute valuation model. This is a reason, for which
various investors and forecasters start the evaluation with this model (Duarte and Rosa,
2015).
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REPORT 5
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
remainder of life of company (Bloomberg, 2018). In the context of Adelaide
Brighton Limited, 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%
Beta 1.48
0
Ke 5.24%
2. Calculation of growth rate-
Growth rate for first 5 years
Retention ratio * ROE
payout ratio 73.94%
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.
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REPORT 6
The GDP growth rate in Australia is 2%.
3. Calculation of dividend-
Two Stage Dividend discount
model
Year Dividend
0 0.2034
1 0.2113
2 0.2195
3 0.2280
4 0.2368
5 0.2460
6 0.2509
4. Calculation of PV
Calculation of PV
year dividend PVF PV
1 0.2113 0.950211 0.20
2 0.2195 0.902901 0.20
3 0.2280 0.857947 0.20
4 0.2368 0.81523 0.19
5 0.2460 0.774641 0.19
Total
0.98

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REPORT 7
5. Calculation of PV of
terminal value
Terminal value
Dividend (6th year)
($)
0.25
09
Growth rate 2.00%
Cost of equity 5.24%
TV 7.
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 5th year
= 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 company or profit
(Ivanovski, Ivanovska and Narasanov, 2015). This ratio is determined by dividing the current
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REPORT 8
stock price of company by the earnings per share (EPS). In the Adelaide Brighton Limited,
the fair value of stock can be calculated as follows-
PE multiple-
PE ratio of
competitor
40.83
EPS of company 27.14
Fair value 11.08
Actual price 4.31
Undervalued Buy
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 of two-stage dividend discount model is that this model is
only applicable to mature corporations and stable corporations who have the proven track
records to pay out the dividend constantly (Barberis, et. al, 2015)
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REPORT 9
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 above risk-free rate is 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 share amongst 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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REPORT 10
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 per CAPM for equity return estimate, two-
stage dividend discount model. Before the investment, it is required to consider all the basic
parameters in relation to these models. As discussed above, the stock of Adelaide
Brighton Limited is undervalued according to all the methods. It is recommended to take the
decision of purchase of stocks.
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REPORT 11
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) Australian Rates & Bonds. [Online] Available from:
https://www.bloomberg.com/markets/rates-bonds/government-bonds/australia [accessed on
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.
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REPORT 12
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 FiveFactor 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.
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