ESTIMATING EXXON MOBIL CORPORATION’S INTRINSIC STOCK VALUE
In this chapter, we described the various factors that influence stock prices and the approaches that analysts use to estimate a stock’s intrinsic value. By comparing these intrinsic value estimates to the current price, an investor can assess whether it makes sense to buy or sell a particular stock. Stocks trading at a price far below their estimated intrinsic values may be good candidates for purchase, whereas stocks trading at prices far in excess of their intrinsic value may be good stocks to avoid or sell. While estimating a stock’s intrinsic value is a complex exercise that requires reliable data and good judgment, we can use the data available in Thomson ONE to arrive at a quick “back-of-the-envelope” calculation of intrinsic value.
1. For purposes of this exercise, let’s take a closer look at the stock of Exxon Mobil Corporation (XOM). Looking at the COMPANY ANALYSIS OVERVIEW, we can see the company’s current stock price and its performance relative to the overall market in recent months. What is Exxon Mobil’s current stock price? How has the stock performed relative to the market over the past few months?
2. Click on “NEWS & EVENTS” on the left-hand side of your screen to see the company’s recent news stories. Have there been any recent events impacting the company’s stock price, or have things been relatively quiet?
3. To provide a starting point for gauging a company’s relative valuation, analysts often look at a company’s priceto- earnings (P/E) ratio. Return to the COMPANY OVERVIEW page. Here you can see XOM’s forward P/E ratio, which uses XOM’s next 12-month estimate of earnings in the calculation. To see its current P/E ratio, click on “FINANCIALS” (on the left-hand side of your screen), scroll down to “WORLDSCOPE” (under Financial Ratios on the left-hand side of your screen), and click on “ANNUAL INCOME STATEMENT RATIOS.” The firm’s current P/E ratio is shown at the top right of your screen. What is the firm’s current P/E ratio?
4. To put XOM’s P/E ratio in perspective, it is useful to see how this ratio has varied over time. Scroll down to the Stock Performance section of this screen. The first two lines of this section show the firm’s P/E ratio using the end-of-year closing price and the 5-year average over time. Is XOM’s current P/E ratio well above or well below its latest 5-year average? Explain why the current P/E deviates from its historical trend. On the basis of this information, does XOM’s current P/E suggest that the stock is undervalued or overvalued? Explain.
5. To put the firm’s current P/E ratio in perspective, it is useful to compare this ratio with that of other companies in the same industry. To see how XOM’s P/E ratio stacks up to its peers, click on “COMPARABLES” (left-hand side of your screen). Scroll down and select “KEY FINANCIAL RATIOS.” At the bottom of the table, you should see information on the P/E ratio of each comparable company in the section titled “Market Value Ratios.” For the most part, is XOM’s P/E ratio above or below that of its peers? In Chapter 4, we discussed the various factors that may influence P/E ratios. Can any of these factors explain why XOM’s P/E ratio differs from its peers? Explain. If you want to compare XOM to a different set of firms, click on “CLICK TO SELECT NEW PEER SET.” (This appears toward the top of the screen.)
6. In the text, we discussed using the discounted dividend model to estimate a stock’s intrinsic value. To keep things as simple as possible, let’s assume at first that XOM’s dividend is expected to grow at a constant rate of 5% annually over time. So, g = 5%. If so, the intrinsic value equals D1 /( rs – g) , where D1 is the expected annual dividend 1 year from now, rs is the stock’s required rate of return, and g is the dividend’s constant growth rate. Go back to the COMPANY OVERVIEW page. Select “FINANCIALS”; and under “FINANCIAL RATIOS,” select “WORLDSCOPE” and “ANNUAL INCOME STATEMENT RATIOS.” On your screen at the bottom of the Per Share Data section, you should see the firm’s annual dividend over the past several years. Multiply the prior year’s dividend by 1 g to arrive at an estimate of D1.
7. The required return on equity, rs, is the final input needed to estimate intrinsic value. For our purposes, you can assume a number (say, 9% or 10%) or you can use the CAPM to calculate an estimate of the cost of equity using the data available in Thomson ONE. (For more details, look at the Thomson ONE exercise for Chapter 8.) Having decided on your best estimates for D1, rs, and g, you can calculate XOM’s intrinsic value. Be careful to make sure that the long-run growth rate is less than the required rate of return. How does this estimate compare with the current stock price? Does your preliminary analysis suggest that XOM is undervalued or overvalued? Explain.
8. It is often useful to perform a sensitivity analysis, where you show how your estimate of intrinsic value varies according to different estimates of D1, rs, and g. To do so, recalculate your intrinsic value estimate for a range of different estimates for each of these key inputs. One convenient way to do this is to set up a simple data table in Excel. Refer to the Excel tutorial accessed through the student companion website for instructions on data tables. On the basis of this analysis, what inputs justify the current stock price?
9. Until now, we have assumed that XOM’s dividend will grow at a long-run constant rate of 5% annually. To gauge whether this is a reasonable assumption, it’s helpful to look at XOM’s dividend history. Go back to the “World scope, Annual Income Statement Ratios” screen. At the bottom of the Per Share Data section, you should see the firm’s annual dividend over the past several years. On the basis of this information, what has been the average annual dividend growth rate? Another way to obtain estimates of dividend growth rates is to look at analysts’ forecasts for future dividends, which can be found under “ESTIMATES” (on the left-hand side of your screen). Near the top of that screen, you should see an area marked “Consensus Estimates.” Use the scroll bar to change from EPS estimates to DPS estimates. What is the median year-end dividend forecast? Also notice that the last line of this area shows the long- term growth rate (LTG). What is the median forecast of the company’s long-term growth rate? On the basis of the dividend history you uncovered in Question 6 and your assessment of XOM’s future dividend payout policies, do you think it is reasonable to assume that the constant growth model is a good proxy for intrinsic value? If not, how would you use the available data in Thomson ONE to estimate intrinsic value using the non constant growth model?
10. Finally, you can also use the information in Thomson ONE to value the entire corporation. This approach requires that you estimate XOM’s annual free cash flows. Once you estimate the value of the entire corporation, you subtract the value of debt and preferred stock to arrive at an estimate of the company’s equity value. By dividing this value by the number of shares of common stock outstanding, you calculate an alternative estimate of the stock’s intrinsic value. While this approach may take additional time and involves more judgment concerning forecasts of future free cash flows, you can use the financial statements and growth forecasts in Thomson ONE as useful starting points. Go to World scope’s Cash Flow Ratios Report (which you find by clicking on “FINANCIALS” under “FINANCIAL RATIOS” click on “WORLDSCOPE” and “ANNUAL CASH FLOW RATIOS”). There you will find historical annual free cash flow per share values. While these numbers are useful as a starting point to arrive at an estimate for the next year, World scope’s definition of free cash flow subtracts out dividends per share. Therefore, to make it comparable to the measure in this text, you must add back dividends. To see World scope’s definition of free cash flow (or any term), go to the top of your screen and click on “GLOSSARY.” A dialog box will appear on the screen. Here, you can select the appropriate database (World scope is shown here now), and then either enter the term or scroll down to find the term for which you are looking for the definition.