Financial Analysis and Valuation Models

This report analyzes the financial performance of Barclays Plc. and explores different valuation models for investment decision-making.

Running head: FINANCIAL ANALYSIS AND VALUATION MODELS
Financial Analysis and Valuation Models
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Executive Summary:
This report is prepared to show the effect of different valuation models on the investment
decision of the investor. In this report, financial performance of the Barclays Plc. has been
analyzed in such a way that investment decision can be made considered for different factors
affecting investment. This report covers the ratio analysis for four previous financial year of
the Barclays Plc., from the information obtained from the financial statement of the company.
This report also indicates the choice of the strategy an investor can made from Buy, Hold and
Sell strategy based on three valuation models and financial performance of the company.

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Table of Contents
1. Introduction:...........................................................................................................................3
2. Stock Evaluation Method:......................................................................................................3
2.1 Dividend Discount Model:...............................................................................................3
2.2 Discounted Cash Flow:....................................................................................................4
2.3 Price to Earnings ratio:.....................................................................................................5
3. Valuation of Share Using Different Models of Valuation:....................................................7
3.1 Valuation Based on Dividend Discount Method (DDM):...............................................7
3.2 Valuation Based on Cash Flow Method:.........................................................................8
3.3 Valuation Based on P/E Ratio:.........................................................................................9
4. Past performance Analysis:....................................................................................................9
4.1 Using Price And Market Capitalization of The Company:..............................................9
4.2 Using Financial Ratios:..................................................................................................12
4.3 Using Comparative Statement of Balance sheet and Income Statement:......................14
5. Conclusion:..........................................................................................................................15
6. References:...........................................................................................................................17

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1. Introduction:
Barclays is a multinational banking company engaged in investing as well as financial
services in London. It provides various financial services in different European countries. it
provides personal as well as business banking services in which facilities like credit and debit
cards, investment planning, locker services, wealth management are offered to the different
types of clients based on their net worth. It was established by john freame as Goldsmith
Bankers but in the end of 1736, it become Barclays bank when the son-in-law of James
Freame has taken over the business of Goldsmith. Through acquisitions and mergers with
different banking companies like the Colonial Bank, National Bank of South Africa and the
Anglo-Egyptian Bank and Non-Banking companies like Mercantile Credit Company,
American Credit Corporation etc , it expended its business to different regions of the world.
2. Stock Evaluation Method:
2.1 Dividend Discount Model:
Dividend Discount Model is a process of valuation of stock price of accompany where the
dividend payment is discounted to the present value of stock price. The stocks are valued on
the basis of net present value for the dividends of the future. Gordon’s growth model is a
renowned growth used in this model. If the DDM of a particular stock is higher then it can be
said that the current value of the stock is undervalued and in case DDM of a particular stock
is lower then it can be said that the value of the stock is overvalued currently (Mohammadian
and Rezaee 2018).
The valuation of the stock can be done in following way:
P = D/ (r – g)

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Where,
P = Price per share, D = estimated value of dividend of next year, g = constant growth rate of
dividend, r = company’s cost of capital equity
The Gordon’s growth model has an assumption, which is that the dividend has a stable
growth rate. The growth rate of this model is stable as the dividend year after year is also
remains stable in that case. It is a process of finding the value of stock with the process of
discounting all the expected future dividends.
The flaws of the dividend discount model are that, with the constant increase in the rate of
dividend. In that case, if the dividend increases then it does not increase at a constant rate. In
order to buy a stock an investor must not only consider that particular stock even if it is cheap
or expensive based on DDM. The particular investor must also consider the following
parameters in case of buying a particular stock, which are return on equity, revenue and
earnings growth, price earnings ratio and the company’s dividend payout ratio, are certain
parameters needed to be considered while purchasing a stock.
2.2 Discounted Cash Flow:
Discounted Cash Flow (DCF) is a method of evaluating the value of investment, which is
based on cash flow related to the future. The expected cash flow of the future converted into
the present value of cash flow by using discount rate. The calculated value of the DCF if it is
higher than the cost of current investment, then such opportunity cost must be considered.
The formula is that DCF = CF1/ (1 + r)1 + CF2/ (1 + r)2 + … CFn/ (1 + r)n
Where,
CF = Cash Flow, r = discount rate

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The main purpose of this model is that the discounting of cash flow is done in such a
situation when the investment is high or rather complicated when the investors is not able to
access the cash flow of the future. DCF analysis is based on the discount rate and there are
various ways to correct the rate of discount, which is depended on the purpose of the
investment. During the time of investment, an investor also could set the DCF rate of
discount, which is equal to the expected return from an alternative investment of the same
kind of risk. This kind of analysis is used in the following cases, which are investment
finance, financial management and valuation of patent. DCF analysis is used in order to
evaluate the Net Present Value, which is considered as input cash flows, and a discount rate,
which further gives output as a present value. The discount rate considered in this method is
the weighted average cost of capital (WACC) which shows the risk in the flow of cash. The
discount rate shows the two things, which are the time value of money and risk premium.
The assumptions that can be made in this case is that the cash flow occurs at the end of the
year. DCF is mostly associated with the big investment projects where there is uncertainty in
the business and the adjustments are made accordingly. All cash flows are invested in various
projects in order to generate return of the company.
2.3 Price to Earnings ratio:
Price to Earnings ratio is a ratio, which is used for the purpose of valuation of a company,
which further measures the current price of the share related to its EPS (Earning Per Share). It
is also termed as the earnings multiples because the current price of share of the company is
related to EPS of the company.
The formula of the P/E Ratio = Market Value per Share / Earning per Share
The P/E ratio is a tool, which is used for determining the value of the stock by the investor for
the purpose of investing. The P/E ratio of a company shows that the market is based on future

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earnings the market pays according to that. According to the P/E, if the P/E of the company is
high then the investors will go for that company and if the P/E of the company is low then the
investors does not prefer those companies. The P/E ratio consists of two types, which are the
Absolute P/E and Relative P/E. Thus, P/E is an important tool considered by the investors in
terms of taking the investment decisions of the company. High P/E of the company will
automatically drag the potential investors in the market. This will help the company to
increase the efficiency of the business smoothly and efficiently. If the return of a company
increases then the stock price of that company decreases. If the risk of investment is higher
then the price of the stock becomes low in that case.
The flaws of the P/E ratio is that in case of taking the investment decision, the investor may
take into their mind that if there is one single metric then it will provide the complete view
into the investment decision taken by the investor which may not be the case most of the
time. When the P/E ratio is compared with different companies then it becomes one of the
flaws in P/E ratio. The valuations along with the rate of growth of the companies between the
various sectors of the companies earn money in various timelines. In case of the same sectors
the P/E is used as an analysis tool and comparisons in this case will give productive return for
the investors. If the growth of the expected dividend increases then the P/E of the particular
company also increases in that case.
If the P/E ratio of different companies within the same sector is high then it will be of less
cause when the entire other sectors has high P/E ratios. In case of debt of the company, the
company having higher debt will have low P/E ratio then the company having low debt. The
business having high debt will considerably have high P/E ratio as that particular company
has taken leverage in that case.

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3. Valuation of Share Using Different Models of Valuation:
3.1 Valuation Based on Dividend Discount Method (DDM):
Interpretation: valuation of shares under Dividend discount Model mainly depends upon the
expectation of the required rate of return of the investor. If the investors want a higher rate of
return, then they will use a higher return to value the stock (Bakshi and Chen 2005).
Therefore, resulting valuation will reflect the undervalued share of the company and vice
versa. In the above calculation, required return i.e. cost of capital is used which is 3.30%
resulting in the value per share of GBP 18.195 whereas the market share price of the Barclays

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plc at valuation date was GBP 198.59. Therefore, the stock is overvalued based on DDM
analysis. The investor should sell the stock and to wait till the stock price below the price as
determined by DDM to get expected return on the stock (Bakshi and Chen 2005).
3.2 Valuation Based on Cash Flow Method:
Interpretation: If there is uncertainty exists in the pattern of the dividend payment of the
company, then the investor should use discounted cash flow method to value the stock of the
company. It shows the return the investor can expect from their investment in particular
stock. As seen from the above calculation, the resultant share price of the stock is lower than
the actual share price then the investor should sell the stock because the expected return from
the stock is lower than the what the investor expects from its investment (Fuller and Hsia
1984).

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3.3 Valuation Based on P/E Ratio:
Interpretation: The P/E ratio indicates the extra amount an investor is going to pay for the
acquisition of the share at market price over and above its value under above method. The
higher ratio indicates the share price of the stock is more relative to the company’s earning
i.e. an increase in the Earning Per share of the stock will result in the upward movement in
the stock price. The higher ratio indicates that stock is overvalued and a lower ratio indicates
that the stock is undervalued but relying on only, the P/E ratio for investing purpose is not a
good idea because other circumstances affecting assumptions of the P/E ratio shall be viewed
accordingly for a rational investment decision (Pástor and Pietro 2003).
4. Past performance Analysis:
4.1 Using Price And Market Capitalization of The Company:
Table showing statistics of past five years Share price and Market Capitalization.

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(Source: uk.finance.yahoo.com)
Chart 1.1 indicating the movement in Share Price.

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The movement in the Market price of the stock shows the investor perspective towards the
buy and hold or sell strategy of particular stocks. The movement in price generally depends
upon many financial factors such as financial ratios, Dividend policy of the company and
such other things, which is a direct reflection of performance of the company. As seen in the
above chart, the price of the stock has unpredictable pattern. So relying on the past price
pattern of the stock is not an appropriate strategy to choose the stock instead the investor
should carefully evaluate the stock based on those factor which are responsible for the
fluctuation in the price of the stock. The price of the stock had started falling from the year
2016 with few upward revisions in the price in the middle of the year. It shows that the
company has not maintain such performance or has week financial report showing decline in
the profit earned.
Chart 1.2 indicating the movement in market capitalization of the company.
There is fall in the price of the stock from the beginning of the year 2016 but the market
capitalization of the company has been increased, which indicates that the company has taken
some steps like bonus issue, shares split and right issue to increase the shareholding

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proportion resulting in the fall in the market price with an increase in the market
capitalization of the company.
4.2 Using Financial Ratios:
Interpretation of Financial Ratios: Financial ratios indicates the performance of the company
in the such a way that future predictions relying on above ratio are somewhere reflect the
reliability of the investment in the company. Financial ratios are the major indicator of the
financial health of the company. Investors, lenders, creditors and government agencies are
mostly concerned with the company’s financial ratios. A good financial ratio indicates
rational and potential investors and increase trust between the company and its major
stakeholders.
As seen in the above table there is a downward trend in the dividend yield of the
company, which is not favorable for those investors who prefer the stock, based on dividend
yield offered. Dividend yield is calculated by dividing total declared of the company by the
market price of the share. Investor who wants more dividend on their shareholding can prefer
this method of performance valuation by purchasing the shares with higher dividend yield.
Net assets per share is the another way to measure the performance of the company.
This method indicates the net assets available in the proportion to the shareholding. This

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method is useful for those investors who are more risk averse or who does not want to take
more risk in relation to their investment made.
Current ratio shows the liquidity position of the company i.e. the ability of the
company to pay its debt when the demand of repayment of debt occur. This method is useful
for the lenders, stakeholders, and the creditors who usually review the pattern of the company
towards related obligation of the company like interest obligation, repayment of creditor’s
due. This method of performance evaluation indicates the creditability of the company
between different stakeholders of the company.
Return on equity shows the Net income available to the equity shareholders. This ratio
is calculated by dividing total net income (PAT) of the company by the total equity
shareholders fund. A positive ratio indicates that the company is adding values in the
shareholders fund whereas a negative ratio indicates that the company has made a loss to the
value of the shareholders fund. As seen above, the company has made 2.04% and 3.45%
value addition in the year 2017 and 2016. So, the company has continuously adding values to
their shareholders with correspondence increase in the trust between the company and
potential investors.

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4.3 Using Comparative Statement of Balance sheet and Income Statement:

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As seen in above comparative statement, the net current assets of the company has increased
since 2014 with a slight decline decrease in the net current liabilities. It means company is
more focused towards maintaining a good liquidity ratio. Its long-term borrowing has been
increased throughout the years, which the company has taken more funds from the lenders to
finance its assets. Increased borrowing means increased interest obligation, which is a direct
charge to the profit of the company. Therefore, company should avoid taking interest-bearing
borrowings.
In the year, 2017 there is a loss from discontinued operation, adjusted with the profit
of the company resulting in overall loss to the company. Therefore, company has to make
proper provision regarding loss from discontinued operations, as their effect on the overall
profit will not result in the loss to the company.
5. Conclusion:
Based on increasing revenue trend, an investor can buy the stock and hold it for longer time
to achieve desired return from the stock but relying only on the Revenue is not a good way
i.e. other factors like Net profit, cost associated with earning such revenue must be reviewed
accordingly to make rational investment decision.
Investment decision of a particular investor depends upon the risk taking capacity of
the investor. An\ rational risk averse will not take higher amount of risk in relation to their
investment whereas a risk-taking person will take higher risk with the expectation of the
higher return from the stock. The application of buy, sell or hold strategy depends mainly
upon the risk taking capacity of the investors. Person with risk aversion attitude will
generally hold the stock for a longer period whereas the person with the higher risk-taking
attitude will sell the share when the desired objective of the higher return is accomplished.

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Based on the dividend discount model, an investor should go for the sell strategy
because the share price of the company is overvalued and market forces will make adjustment
accordingly in the market price.
Based on the discounted cash flow method, an investor should choose Hold strategy
as the positive discounted cash flow of the company, its ability to sustain and generate
positive cash flows from its operations. Investment decision of the investor depends upon the
pattern of the future cash flows, which is a good indication of the company’s performance in
relation to the particular it started. If the project has a positive cash flow then DCF method
will indicate a positive ratio resulting in the more attractive investment in the project.
Based on P/E ratio, the investor is more concerned about the return over the price they
have for their investment. The resulting P/E ratio of the higher as compared to its P/e ratio of
previous year. Investors generally prefer stocks with higher P/E ratio. Therefore, the investor
should buy the stock and hold it until the desired return has been achieved.

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6. References:
Bakshi, G. and Chen, Z., 2005. Stock valuation in dynamic economies. Journal of Financial
Markets, 8(2), pp.111-151.
Brightman, C., Masturzo, J. and Beck, N., 2015. Are Stocks Overvalued? A Survey of Equity
Valuation Models. Research Affiliates Fundamentals.
Callen, J.L., 2016. Accounting valuation and cost of equity capital dynamics. Abacus, 52(1),
pp.5-25.
Dillon, R., 2017. System and method for valuing stocks. U.S. Patent Application 15/444,023.
Fuller, R.J. and Hsia, C.C., 1984. A simplified common stock valuation model. Financial
Analysts Journal, 40(5), pp.49-56.
Ho, K.C., Lee, S.C., Lin, C.T. and Yu, M.T., 2017. A comparative analysis of accounting-
based valuation models. Journal of Accounting, Auditing & Finance, 32(4), pp.561-575.
Lazzati, N. and Menichini, A.A., 2015. A dynamic approach to the dividend discount
model. Review of Pacific Basin Financial Markets and Policies, 18(03), p.1550018.
Pástor, Ľ. and Pietro, V., 2003. Stock valuation and learning about profitability. The Journal
of Finance, 58(5), pp.1749-1789.
Penman, S.H., 2015. Financial Ratios and Equity Valuation. Wiley Encyclopedia of
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Penman, S.H., 2015. Valuation models. The Routledge Companion to Financial Accounting
Theory, p.236.
Saha, A. and Malkiel, B.G., 2015. DCF valuation with cash flow cessation risk.

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Tan, Z., 2017. Application of Discounted Cash Flow Model Valuation–Wal-Mart.
Uk.finance.yahoo.com. 2019. Yahoo is now part of Oath. [online] Available at:
https://uk.finance.yahoo.com/quote/BARC.L?p=BARC.L [Accessed 15 Feb. 2019].
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Williams, E.E. and Dobelman, J.A., 2017. Financial statement analysis. World Scientific
Book Chapters, pp.109-169.
Yu, G., Assad, J.C. and Fuller, P., 2016. Using a Modified Dividend Discount Model for
Stock Market Games.