Topics: Stock, Stock market, Discounted cash flow Pages: 12 (2728 words) Published: March 16, 2013
Prospective analysis
In Wesfarmers, the forecasting next five year chart shows that sales revenue in 2011 will be 8% and it will keep the growth rate at 4% from 2013 to 2015. Because the assets turnover is rarely changed, the report estimate the rate as 1.69, which is the same record as the Wesfarmers 2010 annual report. The profit margin is change largely these years. So the report takes 7.5%, which is the average rate of five year accounting numbers. This report will use the forecasting numbers above, so it can analysis the future performance of Wesfarmers and estimate value per share of common stock for shareholders by following four valuation methods.

1. Discount dividend model
2. Discounted abnormal earnings model
3. Discounted cash flow valuation
4. Discounted abnormal operating earnings model
In 30 June, 2010, the market per share of Wesfarmers is $27.8. Currently, the market share price of common stock is $33.08 in 27 May, 2011. The share price rise about 19%. The current market price is quite close to the results of four valuation models, which use WACC and CAPM to evaluate total value in the Wesfarmers. From the forecasting date, it seems that the common stock is slightly undervalued. The report will choose the most suitable valuation models and give reasonable recommendation for the common shareholders at the end.

Discount dividend model is the foundation of others popular valuation models and the usage is widespread in most firms. In Figure 1, the chart use discount dividend model valued the firm per share at $40.88, which is trading at a $7.8 discount in the market. However, Discount dividend model is not the perfect measure because it not link to value added. Although the firm value will seem to be higher, there is no actual value create into the wealth. In other words, this model is focus on creation of capital, instead of division of capital.

Discounted abnormal earnings model forecasts residual income which measures the value added in Wesfarmers. The model requires high experience accountants who can deal with complex accounting records and understand the principal of accounting. The common shareholders may think that accounting numbers can be doubtful and hard to find the truth. However, this is one of models which close to the real total value of Wesfarmers. In Figure 2, the value of firm per share is $33.75, which is slightly above market share price. It shows that Wesfarmers is trading at $0.67 discount. Opposite to Discount dividend model, it treats investment as asset and recognize value added into abnormal earnings. It more cares about the whole creation of capital in the Wesfarmers.

For discounted cash flow valuation, the value per share of common stock is $40.33 (Figure 3). Compared to the market value, the result shows that the share price of Wesfarmers is largely undervalued at $7.2 discount. Although cash flows are ‘real’ number and people can easily understand the outcomes, the discounted cash flow valuation is not suitable to Wesfarmers. According to the five years annual reports, the investment pattern is growth 4.2% in 2010 and -23.6% in 2009, which are not growing at a constant rate like free cash flow. Moreover, cash flow does not include any value added in the short-term investment. As a consequence, the investments are treated as value loss.

In the figure 4, the chart shows that discounted abnormal operating earnings model value of the firm per share at $33.88. The market share price of Wesfarmers is undervalued by $0.8. The model is based on WACC to calculate the total value of Wesfarmers. Compare to other models, the cost of capital only adjusted when the leverage changes each time. As a consequence, it is easy to use and less complex than discounted abnormal earnings model. The model is the most suitable for recommendation of Wesfarmers because it focuses on the growth pattern of NOPAT and net operating assets which are the important factors to the...
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