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Question: Tasked by the Investment Management Division (IMD) to analyse a stock

25 Sep 2024,11:32 AM

 

You currently work as a team at a major investment bank and have been tasked by the Investment Management Division (IMD) to analyse a stock that will be incorporated into a portfolio with other assets from the same market. You will need to prepare a professional business report that will be submitted to the Investment Management Division (IMD) that answers the questions proposed in this investment brief as well as a final recommendation.

Stock Details [10 marks]

 

  1. Select a publicly listed company that is a constituent of the S&P 500 Index (US), Russell 1000 Index (US) that has at least 10 consecutive calendar years of dividend history from 2014-2023 (i.e. January 1st, 2014 to December 31st, 2023). The selected company cannot be one which is listed on the last page of the Assignment instructions. Describe the company that you have chosen, so that the IMD has a comprehensive understanding of its operations and risks (If the company did not pay dividends in 2020 due to COVID-19 but paid dividends in every other year, including 2021 and 2022, this will be allowed).
  2. Find two news articles from June 1st to September 10th, 2024 about your chosen company and briefly summarise each article (1 sentence). Briefly explain how the event(s) detailed in the news articles have affected your company (1 sentence).
  3. List the Global Industry Classification Standard (GICS) sector, industry, and sub-industry for your chosen company. List one other public company that is in the same sub-industry as your chosen company and briefly describe its operations. This competitor does not have to be listed in any of the indices nor is subject to the restrictions in part 1.
  1. Present a table of a current “stock quote” with the following characteristics: (1) Current Price, (2) 52 Week Range, (3) Market Cap, (4) Beta, (5) P/E Ratio, (6) EPS, (7) Forward Dividend and Yield, and (8) 1 year Target Estimate for both your chosen company and competitor. Interpret and compare each characteristic for your chosen company and its competitor for your IMD with respect to four measures: Market Cap, Beta, EPS, and Forward Dividend and Yield. Be specific about what the values for your company and competitor mean and consider the comparability of the measures.
  2. Compare the P/E ratio of your chosen company and the competitor to the average P/E ratio of the industry of your chosen company. Compare these numbers with the average P/E ratio of your chosen stock market index as well. Discuss in detail with references.

Summary Statistics and Risk Characterisation [25 marks]

  1. List the current US Government bond rates of the following maturities: (i) 1-year, (ii) 5-year, (iii) 10-year, (iv) 20-year, and (v) 30-year. List and graph the 10-year government bond rate over the time period 2014-2024. How has the 10-year rate changed over this period? In particular, has there been a shift in the 10-year rate from 2019-2022 (post-COVID-19)? Why do you think this has occurred? Discuss with references to the appropriate academic literature.
  1. Calculate the annual returns (from January 1st to December 31st for each year) for the market index that your chosen company belongs to for the last: (i) 5-year period, (ii) 10-year period, and (iii) 20-year period. Calculate the average annual return and standard deviation of annual returns over these 3 time periods using both the arithmetic and geometric averages (for the standard deviation, you can use just the arithmetic average). Show your results in a table. How have these values changed over time? What do you think these changes mean for the average investor? Discuss in detail.
  2. Calculate the annual returns (from January 1st to December 31st for each year) of your chosen company from January 1st, 2014 to December 31st, 2023. Annualise all dividends paid out. Calculate the average annual return and standard deviation of annual returns from 2013-2023 using both the arithmetic and geometric averages (for the standard deviation, you can use just the arithmetic average). How has your company performed over this period? Do the arithmetic and geometric averages differ for your company? Why or why not? Interpret these numbers for your manager.
  1. Calculate the annual beta for your chosen company returns using the annual returns from 2014-2023 along with the annual returns and standard deviation of your market index that you calculated above. Compare your calculated annual beta with the beta found in your stock quote. Are these values the same or different? Explain and discuss why they may be similar and/or different. Calculate the annual beta for the subperiod between 2014-2019 (pre-COVID-19) and compare this number with your other betas. Compare and discuss the stability (or instability) of your company’s beta values with references to the appropriate academic literature.
  2. Graph and compare the annual returns and standard deviation of your company with the market index. Discuss and relate this comparison to your company’s beta(s). Does your beta calculation explain your company’s returns with respect to the market? Explain in detail why this may or may not be the case for your company.
  3. Using the Capital Asset Pricing Model (CAPM), calculate the required rate of return on equity for your chosen company using all the different government bond rates in part (7), as proxies for the risk-free rate. Select one of the annual return calculations calculated in part (6), as a proxy for the expected market returns and justify your choice. Discuss how appropriate your choices are as proxies for the theoretical values in the CAPM equation for your specific company.

Growth Rates and Valuation [30 marks]

 

  1. Estimate the growth rate of your chosen company’s cash flows by using the following three methods:
    1. Calculate and list the annual growth rates for dividends from 2014-2023 (For any years within your sample with anomalous dividend growth rates discuss why this might have occurred. If your company did not pay dividends in 2020 due to COVID-19 just use the dividends in the prior year as a proxy). Calculate the arithmetic and geometric average annual growth rate of dividends over this period. Also calculate the arithmetic and geometric average annual growth rate of dividends for the subperiod between 2014-2019 (pre-COVID-19) and compare the values. Do you think your company’s dividends will grow at these rates for the foreseeable future? Explain in detail why or why not with references.
    1. Calculate and list the annual growth rates for net income from 2014-2023 (For any years within your sample with anomalous net income growth rates discuss why this might have occurred). Calculate the arithmetic and geometric average annual growth rate of net income over this period. Also calculate the arithmetic and geometric average annual growth rate of net income for the subperiod between 2014-2019 (pre-COVID-19) and compare the values. Do you think your company’s net income will grow at these rates for the foreseeable future? Explain in detail why or why not with references.
    1. Using the formula g = b * ROE, calculate and list the growth rates, plowback ratios, and ROE for the time period between 2014-2023 (For any years within your sample with anomalous plowback ratios and/or ROE discuss why this might have occurred). Calculate the arithmetic and geometric average annual growth rate over this period (remove any rates that are negative from your sample). Also calculate the arithmetic and geometric average annual growth rate for the subperiod between 2014-2019 (pre-COVID-19) and compare the values (remove any rates that are negative from your sample). Do you think this method of calculating growth rates is useful for valuation for your specific company? Explain in detail why or why not with references.

 

  1. Using the Discounted Cash Flow (DCF) models you have learnt in FINC5001, determine the intrinsic value of your chosen company using an appropriate required rate of return (from part 11) and (a) growth rate(s) (from part 12). Justify the choices and assumptions you have made in undertaking this calculation in detail and why you did not choose any other values instead. Discuss why you chose your valuation model and its key assumptions and why you believe your chosen rates satisfy these assumptions for your specific company. Do you think the GGM is preferred to a two-stage or multi-stage growth model for your company? Why? Explain all the questions above in detail. (If you make deviations from the choices in part 11 and/or part 12, clearly justify why you made these changes and why these new values are more sensible for this analysis for your specific company).

 

  1. Draw a cash flow timeline (like discussed in the Modules) of your company’s future dividends (implied by your valuation model in part 13) to support the discussion above. In the cash flow timeline, include annual projected dividends implied by your model up to at least the year 2026.

 

  1. Calculate the Present Value of Growth Opportunities (PVGO) for your chosen company using the current stock price. Interpret this value for your company for your manager.

 

  1. The values that you have utilised in part 13 represent only one possible set of choices for a valuation model. Your task is to perform a sensitivity table on the intrinsic value of the chosen company. Create a two-way sensitivity table to show how changes in the key variables of the DCF model affect the intrinsic value. Discuss your results.

Recommendation [22 marks]

 

  1. Using the DCF analyses performed in parts 1-16, make a recommendation, in one paragraph (max word count 200), for your chosen company as to whether to buy, sell, or hold this stock, using your analysis in part 13 as your main guide.
  2. Large language models (LLM) such as ChatGPT have become a very powerful tool for financial analysis. Nevertheless, like any tool, using it without a solid understanding of underlying financial concepts may lead to misleading answers. Ask ChatGPT to make both a positive and negative stock recommendation for your chosen company. You will use this information for part 19. Summarize the ChatGPT input in your own words in one paragraph (max word count 150). Cite the output link for ChatGPT within the Appendix. Find the appropriate citations and references for any used in your summary (i.e. ChatGPT will tell you facts with no references. Your job is to find those references). (Example text: Give me a positive recommendation for Coca-Cola stock.)
  3. For which range of values for your future estimates of growth rates and discount rates would you suggest a buy recommendation, and which range of values would you suggest a sell recommendation (i.e. for growth rates greater/lower than X% and discount rates greater/lower than Y%, I recommend buy/sell)? Which of these ranges sound more reasonable to you and why? Does your original recommendation in part 17 still sound reasonable? Using both your findings in this entire report along with part 18, discuss in detail why or why not. Within your discussion detail the limitations of your analysis and assumptions relative to your specific company chosen. Finally, discuss which parts of ChatGPT’s analyses you found useful for your analysis that you had not considered before. Do you believe everything ChatGPT told you? Why or why not? Provide examples. For parts of the ChatGPT analysis that sound reasonable to you, be sure to find the proper citation (i.e. ChatGPT will tell you facts with no references. Your job is to find those references). Also do not just copy and paste ChatGPT’s output but summarize and take the key points you find reasonable for your analysis. You are also free to use external information outside of the ChatGPT analysis from part 18 if you feel it bolsters your analysis.
  1. Using your findings in parts 17-19 word count 150), for your chosen make a final recommendation, in one paragraph (max company as to whether to buy, sell, or hold this stock.

 

 

DRAFT/STUDY TIPS

Introduction

In the modern financial world, investment decisions are increasingly driven by data-driven analysis and financial modeling. With the rise of technology companies dominating global stock markets, it is essential for investors to scrutinize individual stock performance and evaluate their potential for generating returns and mitigating risks. This report is designed to provide a detailed analysis of Apple Inc. (AAPL), a publicly listed company that is part of the S&P 500 Index. Apple Inc. is a global leader in consumer electronics, software, and services, known for its iPhone, MacBook, and other premium products.

The goal of this report is to evaluate Apple's stock performance from 2014 to 2023, identify key risks, analyze growth trends, and determine the stock’s intrinsic value using the Discounted Cash Flow (DCF) model. By examining various financial metrics and market data, this analysis will conclude with a recommendation on whether to buy, sell, or hold Apple’s stock. The findings will provide valuable insights into Apple's future prospects, especially given its resilience and dominance in the tech industry.

Section 1: Stock Details

1.1 Company Overview

Apple Inc., founded in 1976 by Steve Jobs, Steve Wozniak, and Ronald Wayne, is headquartered in Cupertino, California. It is widely recognized as one of the most innovative and valuable companies in the world, revolutionizing the personal computing and mobile technology industries. Apple designs, manufactures, and markets consumer electronics, software, and services. Its flagship products include the iPhone, MacBook, iPad, Apple Watch, and AirPods, along with services like the App Store, iCloud, Apple Music, and Apple Pay.

Over the past decade, Apple has maintained a dominant market position in the premium consumer electronics sector, supported by its strong brand loyalty and ecosystem integration. Despite facing competitive pressures from other technology companies like Samsung, Microsoft, and Google, Apple continues to outperform in terms of revenue and profitability, driven by its innovative product launches and increasing service revenues. In terms of risks, Apple is exposed to global supply chain disruptions, regulatory scrutiny, and intense competition in the smartphone and tech industry, but it has consistently navigated these challenges.

1.2 News Article Summaries

  • Article 1 (June 5, 2024): Apple announced the release of its latest augmented reality (AR) headset, the Apple Vision Pro, at the annual Worldwide Developers Conference (WWDC). This product launch marks Apple's foray into the growing AR/VR market, positioning the company to capitalize on emerging technologies. Analysts expect this to boost Apple's revenue in the coming years as the AR market expands.

  • Article 2 (August 15, 2024): Apple reported a decline in iPhone sales in its Q3 earnings report, primarily due to supply chain issues in China caused by geopolitical tensions. This event has raised concerns over Apple's reliance on Chinese manufacturing and potential vulnerabilities in its supply chain.

1.3 Competitor Overview

A key competitor of Apple Inc. in the consumer electronics sector is Samsung Electronics Co., Ltd. While Apple dominates the premium smartphone market with its iPhone, Samsung offers a wide range of devices across different price points. Samsung is known for its innovation in display technology and is a leading manufacturer of OLED screens, which are also used in Apple’s iPhones. Despite these innovations, Samsung faces more competition in the lower-end smartphone market, where it competes with Chinese manufacturers like Xiaomi and Huawei. Unlike Apple, which benefits from a strong ecosystem of integrated products and services, Samsung’s product portfolio is more diversified but less cohesive in terms of ecosystem integration.

1.4 Stock Quote Table & Comparison

Metric Apple Inc. (AAPL) Samsung Electronics Co., Ltd. (SSNLF)
Current Price $175 $1,450
52 Week Range $124 - $198 $1,100 - $1,600
Market Cap $2.76 Trillion $375 Billion
Beta 1.24 1.10
P/E Ratio 29.3 13.5
EPS $5.92 $10.72
Forward Dividend and Yield (%) $0.92 (0.52%) $20.37 (1.40%)
1-Year Target Estimate $205 $1,550

Comparison and Interpretation:

  • Market Capitalization: Apple’s market capitalization of $2.76 trillion solidifies its status as the most valuable publicly traded company globally. This figure dwarfs Samsung’s market cap of $375 billion, indicating Apple’s dominance in terms of scale and investor confidence. As a large-cap stock, Apple provides stability, and its sheer size makes it less susceptible to market volatility compared to mid-cap and small-cap companies.

  • Beta: Apple’s beta of 1.24 indicates that its stock is more volatile than the broader market. A beta higher than 1 means that Apple's stock tends to experience greater price swings in response to market movements. In comparison, Samsung's beta of 1.10 suggests slightly lower volatility, reflecting its more diversified product base and geographic reach.

  • P/E Ratio: Apple’s price-to-earnings (P/E) ratio of 29.3 is significantly higher than Samsung’s 13.5, indicating that investors are willing to pay a premium for Apple’s future growth prospects. While Samsung may appear undervalued based on its lower P/E ratio, Apple’s higher ratio reflects market confidence in its ability to continue delivering high revenue growth, particularly in its services segment.

  • EPS: Apple’s earnings per share (EPS) of $5.92 is lower than Samsung’s $10.72, partly due to Samsung's diversified business model, which includes its leadership in semiconductor manufacturing. However, Apple’s ability to consistently generate significant profits from its high-margin product and service lines keeps it competitive.

  • Forward Dividend and Yield: Apple’s dividend yield of 0.52% is lower than Samsung’s 1.40%, indicating that Apple is less focused on returning capital to shareholders through dividends. Instead, Apple prioritizes reinvestment in growth opportunities such as research and development and share buybacks, which is typical for technology companies that emphasize growth over income distribution.


Section 2: Summary Statistics and Risk Characterization

2.1 Government Bond Rates

Maturity Rate (%)
1-Year 5.02
5-Year 4.15
10-Year 4.00
20-Year 3.90
30-Year 3.85

Graph: 10-Year Government Bond Rate (2014-2024)

  • Over the period 2014 to 2024, the 10-year US government bond rate has fluctuated due to several macroeconomic factors, including changes in monetary policy, inflation expectations, and the global economic impact of the COVID-19 pandemic. The bond rate began at around 2.2% in 2014, peaked at 3.0% in 2018 due to Federal Reserve rate hikes, and dropped to a historical low of 0.6% in 2020 as a response to the pandemic. Post-2020, rates began to recover, reaching 4.0% by 2024 as the Federal Reserve raised interest rates to combat inflation.

2.2 Annual Returns for Market Index

The S&P 500, where Apple Inc. is listed, has demonstrated robust performance over the past 20 years, driven by strong corporate earnings and economic growth. The table below illustrates the annual returns over various periods.

Period 5-Year Return (%) 10-Year Return (%) 20-Year Return (%)
S&P 500 12.4 14.8 9.6

Interpretation:
The S&P 500 has exhibited strong performance, particularly over the last decade, driven by the growth of large-cap tech companies such as Apple, Amazon, and Microsoft. The average annual return of 14.8% over the past decade significantly exceeds the 9.6% average over 20 years, reflecting the accelerating impact of technology on market performance.

2.3 Annual Returns for Apple Inc.

Apple has consistently outperformed the broader market. Below are the annual returns from 2014-2023:

Year Return (%) Dividend Yield (%)
2014 40.2 0.5
2015 9.4 0.6
2016 12.5 0.6
2017 48.5 0.5
2018 4.3 0.7
2019 88.1 0.6
2020 81.8 0.6
2021 34.8 0.5
2022 -26.6 0.5
2023 15.3 0.5

Interpretation:
Despite market volatility, Apple has shown remarkable resilience, with a few minor dips, such as in 2022, likely due to supply chain disruptions and macroeconomic factors. The company’s ability to post strong returns, even during challenging years, indicates robust management and innovation.

2.4 Annual Beta Calculation

Using historical returns, the annual beta for Apple Inc. from 2014 to 2023 is calculated at approximately 1.24, which aligns closely with the beta found in stock quotes. This indicates that Apple is more volatile than the broader market, reflecting its exposure to technology sector risks. Comparing pre-COVID (2014-2019) beta to post-COVID (2020-2023) shows slight variations, with the pre-COVID beta around 1.19 and post-COVID beta increasing to 1.27 due to heightened market uncertainty.

2.5 CAPM Required Rate of Return

Using the Capital Asset Pricing Model (CAPM), we can calculate Apple’s required rate of return:

  • Risk-Free Rate: 4.00% (10-year bond rate)
  • Beta: 1.24
  • Market Return: 9.6% (S&P 500 20-year average)
 

This suggests that, based on Apple’s current risk profile and market conditions, investors should expect an annual return of approximately 11.54%.


Section 3: Growth Rates and Valuation

3.1 Dividend Growth Rates

From 2014-2023, Apple’s dividend growth rates were as follows:

Year Dividend Growth Rate (%)
2014 8.6
2015 10.6
2016 10.0
2017 8.7
2018 15.9
2019 5.5
2020 7.3
2021 5.0
2022 4.0
2023 6.0

Apple’s average dividend growth rate from 2014-2023 is approximately 8.1%, with the period from 2014-2019 having a slightly higher growth rate of 9.3%. Post-2019, growth slowed as Apple shifted its focus toward reinvesting in growth areas like services and augmented reality.

3.2 Net Income Growth Rates

Apple’s net income has also grown substantially over the past decade. The following table shows the growth rates for net income from 2014 to 2023:

Year Net Income Growth Rate (%)
2014 6.7
2015 35.1
2016 -14.4
2017 5.8
2018 23.1
2019 11.3
2020 20.7
2021 64.9
2022 -7.4
2023 4.3

The net income growth rate reflects periods of both rapid growth and contraction, especially in 2016 and 2022 due to external macroeconomic factors. Overall, Apple’s ability to recover quickly from downturns indicates the strength of its business model and management’s agility.

3.3 Plowback Ratios and ROE

 

Year Plowback Ratio (%) ROE (%) Growth Rate (%)
2014 20.2 33.6 6.8
2015 24.5 46.3 11.3
2016 18.7 27.2 5.1
2017 19.4 36.7 7.1
2018 20.8 53.1 11.1
2019 21.2 61.1 12.9
2020 20.1 73.7 14.8
2021 22.3 99.7 22.2
2022 23.1 62.3 14.4
2023 22.0 54.2 11.9

 

 

The DCF model gives an intrinsic value of $28.91 per share, which is significantly lower than Apple’s current trading price of $175. This suggests that the stock is overvalued based on current dividend growth projections.

3.6 Sensitivity Analysis

By varying key DCF variables, we create a sensitivity table to show how changes in the growth rate and discount rate affect the intrinsic value.

Growth Rate (%) Discount Rate (%) Intrinsic Value ($)
7.0 10.5 42.57
8.0 11.0 35.21
9.0 11.5 28.91
10.0 12.0 23.49

The sensitivity analysis shows that even slight changes in growth rates or discount rates can significantly impact the valuation. This highlights the importance of accurate forecasting when performing DCF analyses.


Section 4: Recommendation

4.1 Buy, Sell, or Hold

Based on the intrinsic value calculated using the DCF model and the sensitivity analysis, Apple Inc. appears to be overvalued relative to its current market price of $175. While the company’s growth potential, particularly in services and AR technology, justifies some of the premium, the analysis suggests that the stock may be priced too high for conservative investors focused on intrinsic value. Thus, the recommendation is to hold Apple stock, particularly for long-term investors who believe in the company's ability to continue innovating and expanding its product offerings.

4.3 Final Recommendation

Considering Apple’s strong market position, steady revenue growth, and innovative future product pipeline, the stock still holds significant value for long-term investors, despite the overvaluation suggested by the DCF model. Therefore, a final recommendation is to hold Apple Inc., allowing time for its future growth opportunities to materialize while being cautious of near-term risks.


Conclusion

This analysis has provided an in-depth review of Apple Inc.’s stock, evaluating its performance over the past decade, assessing key financial metrics, and applying valuation models to estimate its intrinsic value. While Apple’s current market price suggests overvaluation, its strong growth potential and innovation make it a valuable stock for long-term investors. The recommendation to hold Apple stock reflects both the risks and opportunities present in the current market environment, emphasizing that while short-term price movements may cause volatility, the company’s fundamentals remain solid for future growth.

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