Discussion of Dvm, Peg Ratio, P.E Ratio with Examples from Kelloggs

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Analysis of the Kellogg’s organisation and discussion of the modelling methods used

Introduction

Below is a financial report analysing whether the Kellogg’s company (K) is worthy of investment. To do this I will examine their historical data and financial information; then from these, make calculations and model the company’s situation (This information report was obtained from http://uk.finance.yahoo.com). After calculating the models I will be able to compare them with the actual stock price and other information of their competitors. This essay will outline both the strengths and weaknesses of each of the models used, and how they apply to Kellogg’s. I will be particularly focusing on: Beta Calculations, Dividends Valuation Model (DVM), Price to Earnings ratio (P.E Ratio), PEG Ratio and Cash flow methods.

Kellogg’s is a major producer of cereal and convenience foods, with their brands including cookies, crackers, toaster pastries and cereal bars. Kellogg’s products are manufactured in 18 countries and marketed in more than 180 around the world. The global headquarters are located in Michigan, USA, while their largest factory in Manchester.

Kellogg’s trades on the New York Stock Exchange under the ticker symbol NYSE: K, while its market capitalisation is 18.72billion and has 357 million issued shares.

Valuing the share price

Dividend Valuation Model (DVM)

The dividend valuation model is based on the fact that the market value of the ordinary shares represents the sum of the expected dividend flows discounted to present value. The model works on the premise that the shareholder will expect two different types of return: income from dividends and a capital gain from the future sale of the share for an inflated price.

If we assume that the dividends do not change over time we can use the following formula.

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Unlike this model, most companies will not have a fixed dividend; theirs will grow year on year. The growth rate of a company’s dividend is difficult to predict, but many attempt to in different ways. The most popular method involves examining previous year’s dividends and then extrapolating the future growth rate. Utilising this I achieved a value of 4.8% which I used for the first 5 years; I then reduced the growth by 0.25% annually since a sustained growth rate is unrealistic.

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The table was also obtained from the Excel sheet; it shows the calculated stock price is $59.20, which is marginally higher than the actual stock price by $6.01. Whilst being a small difference, this means that the stock should eventually increase in value subsequent to purchase.

Problems with the model DVM

Not all companies pay dividends and as a result it is impossible to calculate the model in the same way; if there is no value of dividends then the only capital gain will be from selling the shares at an increased share price. “As with any model it is only as good as the figures used, so in this case the estimate for future growth rate which can have a large impact on the overall valuation of the stock.” (Gehr, 1992) The prediction of the future growth rate of the dividends is difficult as it depends on many variables, such as the decisions of the manager and shareholders, and the current economic situation of the company. Therefore as with any other model, it is important to carefully calculate estimates before conducting the model.

Calculating beta

The market has a beta of 1; a stock with a beta greater than 1 is seen to be more volatile than the market, whereas a stock with a beta less than 1 is vice versa. So it is essentially a measure of the stocks’ systematic risk.

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Beta can be calculated over a number of different years and there doesn’t appear to be a standard time interval that every organisation uses, for example some only use short term estimates like the preceding 5 years, whilst some may use figures from when the business first...
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