Explanation of Investment and Portfolio Management

Question: Discuss about the Explanation of Investment and Portfolio Management. Answer: Introduction The following assignment presents the explanation and concept of share valuation by analyzing the securities of a listed company in Australia. The study aims to determine and present the correct valuation, over valuation or under valuation of securities by considering different methods of share valuation. For the purpose of share valuation and analysis, Woolworths Limited has been selected that is listed on Australian Stock Exchange and included in the top 200 stocks as per market capitalization value (Asx.com.au 2017). Further, share valuation and analysis has been done by considering two types of valuation i.e. absolute valuation and relative valuation. Absolute valuation is considered to measure the intrinsic value of securities based on the fundamentals like cash flow, dividends or growth rate of the organization. On the contrary,relative valuation is considered to present comparable valuation of the securities along with the share valuation of other similarorganizations (Damodar an2016). Accordingly, in order to present the share valuation analysis of Woolworths Limited different models of absolute valuation has been considered. Discussion Background of the company: Woolworths Limited is a public company and second largest organization in Australia in view of the amount of revenue. The company was founded in the year 1924 having its headquarters at New South Wales, Australia while it serves the business in New Zealand and India. According to the current reports on business valuation, the organization has been valued at $30.2 billion whereas the operating income reported at $1.6 billion(Woolworths 2016). It has been observed that the number of locations of the organization reported to more than 3,800 in Australian region. Further, primary business operation of the company includes Australian food and Petrol representing two- third of its total revenue ($39.4 million), revenue from drinks group amounted to $7.58 million and other departmental stores and hotels including the stores of liquor that derives the income of around $6.53 million (Woolworths 2016). Analysis of current valuation: Current valuation of Woolworths Limited involves enterprise valuation that is measured in accordance with the current market valuation by considering the value of liquid assets, outstanding debt and value of equity instrument. Accordingly, the enterprise value of the company is determined by using the value of market capitalization, value of debt deducted by the amount of cash. Currently, the enterprise value of the organization has been reported amounted to $33.56 Billion, which is lower than other sectors in service industry, approximately by 89.26% while 61.55% lower than of the sector involved in grocery industry(Asx.com.au 2017). Currently, the shares of the company have been valued at $24.38 while dividend yield on annual basis reported at 3.16%. It has been noted that the return on assets of the company was 6.56% whereas profit margin reflected negative balance (2.12) percentage and operating margin at 4.40%(Asx.com.au 2017). In order to determine the correct valuation of the securities of Woolworths, absolute valuation would be considered based on the dividend discount model, price earnings ratio, earnings per share model and growth rate model. As per dividend discount model, true valuation of the securities would be measured based on the dividend payment to the shareholders (Andriosopoulos and Lasfer2015). Valuation of securities under this methodology would be considered on the basis of present value of cash value based on the actual payment of dividend amount. It is essential that the payment of dividend should be stable and involves predictable amount considering the growth rate for dividend per share or earnings per share. Valuation of shares as per dividend discount model is estimated by considering dividend growth rate and related rate of discount used to measure the present value (Cornell 2013). Considering the recent data of Woolworths Limited, following equation will be used to measure the present value of securities of Woolworths i.e. Dividend per share/ (Discount rate- Growth rate). As per the current years annual report, dividend per share of the company for the financial year 2011, 2012, 2013, 2014 and 2015 has been 122 cents, 126 cents, 133 cents, 137 cents and 139 cents respectively(Woolworths 2016).The discount rate for Woolworths Limited to be 8% while the growth rate 5% based on the recent years financial information has been assumed. Hence, it can be said that Woolworths dividend payment reflects constant growth over the years in accordance with the earnings. Accordingly, share value of Woolworths for the year 2015 would be measured as $1.39/ (0.08- 0.05) = $46.33 whereas share value for the year 2014 would be $1.37/ (0.08- 0.05) = $45.67(Woolworths 2016). On the contrary, present market value of the securities of Woolworths has been $24.27 hence, the share value of Woolworths as per dividend discount model is said to be undervalued. Since the present valuation of securities of Woolworths has been undervalued, the investors can be recommended to go long on trading the securities. In addition, share valuation can be measured by using another model in absolute valuation i.e. Discounted Cash Flow Model that is used to determine the correct share valuation using future cash flows. This method is mainly preferable to measure the share valuation for the organizations that does not pay dividend. In order to measure the value of business or securities forecasted free cash flow based on the previous years performance as well as based on growth rate (Cumming and Hou2014). As per the financial information of Woolworths Limited, free cash flow during the recent year has been $2,167million; cash flow from operating activities amounted to $4,711.1 million whereas cash flow used in investment activities $1,055.7 million(Woolworths 2016). It was noted that the cash flow from operating activities and used in investing activities declined in the current year in comparison to the previous year. Accordingly, share value as per discounted cash flow model would be determinedby con sidering discounted cash flow of the year along with the use of growth rate i.e. $2,167/ (1+8%) = $ 2,006 i.e. $30.45. As the current price of security of Woolworths has been $24.27 therefore, share valuation of the company as per discounted cash flow model is undervalued and investors either can purchase the shares or can hold the same. For the purpose of appropriate valuation of shares, Earnings per share methodology can be considered, which refers to the amount of net income attributable to the shareholders of the organizations divided by the outstanding shares during the financial year (Raza and Jawaid2014). In certain cases, earnings per share of the company is adjusted by excluding certain non- cash items i.e. amount of goodwill amortization or expenses on stock valuation. For the purpose of appropriate valuation of shares, it is essential to consider volatility of companys EPS for several years (Goodman and McLelland2016). In view of the financial report of Woolworths Limited for the recent financial year, basic earnings per share of the company during the year 2015 was 170.8 cents whereas 196.5 cents during the year 2014. It has observed that the earnings of the company declined in the recent years in compared to the earnings of 2014(Woolworths 2016). On the other hand, price earnings ratio of the companys se curities is important to consider that provides information on stock price in relation to the earnings for a particular financial year. If the computed price earnings ratio of the company is less than the benchmark of the industry, the shares would be considered undervalued whereas if the price- earnings ratio of the company is higher than the industry benchmark, share of the company would be considered as overvalued (Gregory and Whittaker 2013). As per the current financial economy, standard price earnings ratio 15 is considered while P/E ratio of the company Woolworths has been reported at 12.81 that is lower than the industrial benchmark. Therefore, it can be said that as per the earnings per share and price- earnings ratio, share price of Woolworths limited is undervalued and the investors can go long (Asx.com.au 2017). Growth rate on sales and income is also considered for measuring the valuation of shares of the company based on the historical judgments and future prediction. Valuation on shares based on the growth rate would be sales revenue and other income during the financial year and in comparison to the benchmark of the industry. Growth rate is used to determine the appropriate share price along with the factors of discounting rate and dividend per share. If the value of dividend of the company expects to grow over the period, the stock will be considered as constant growth security (Wang 2013). In case of Woolworths Limited, it has been noticed that the companys dividend for the past years along with that in current year has been increasing whereas revenue income of the company declined in the year 2015. Hence, if the method of constant growth model is considered, valuation of share will be measured by using current dividend amount, expected growth rate and required return (Kung and Schmid2 015). Considering the current financial information of Woolworths, current dividend amounted to $139 cents is provided while expected growth rate is 5% assuming the required rate of return on the security investment would be 12% as per the industrial benchmark(Woolworths 2016). Therefore, price of the share of Woolworths Limited would be determined as $20.85 i.e. [$1.39 (1+.05)/12-0.06] whereas current market price of the share is $24.27. In view of the growth rate model, considering the valuation of securities, it can be said that the companys present share valuation is overvalued and the investors are recommended to go short. Overvaluation and undervaluation of shares is determined by considered the percentage of return on organizational capital, assets, sales as well as market capitalization. Return on invested capital is used to measure the amount of investment in terms of capital that provides information on growth level and derivation of capital return against the amount of cost of capital(Pan, Wang and Weisbach2015). If the return on investment capital is higher then it can be said that the company is efficient and ratio on companys income with that of the invested capital would determine the correct valuation of shares (Wachter2013). In case of Woolworths Limited, invested capital during the current year 2015 amounted to $11,132 million whereas the net income amounted to $2,137 million, therefore return on invested capital would be 19.19%(Woolworths 2016). It can be said that the percentage of return on invested capital is higher than the standard required rate of return i.e. 12% and the valuation o f shares can be said to be undervalued and the investors can go long on the shares. Similarly, return on assets provides the measurement of the efficiency of the organization to generate business income from the use of assets. In order to determine the return on assets, total income after tax as well as total value of assets is to be considered during the financial year. Considering the return on assets, if the return is higher than the expected return, the valuation of the shares is said to be overvalued whereas if the return on assets is lower than the expected value then shares would be considered as undervalued (Dechow, Sloan and Zha2013). Considering the current years financial information, total value of assets of the company is $25,336 whereas net income amounted to $2,137 million. Therefore, return on organizational asset to be determined as 8.43% while the expected return considered is 12%, which is higher than the computed value(Woolworths 2016). Since, the expected return on investment of securities is higher than the actual current rate of return from as sets, shares of Woolworths can be considered overvalued and investors are advised to go short. Other factors that are used to measure the correct valuation of securities involves price to sales ratio, market capitalization, enterprise value and sales ratio as well as enterprise value and earnings before interest and tax ratio. Price to sales ratio is used to compare the current market price of the companys shares along with the amount of sales earned during the financial year (Greenwood and Shleifer2014). Sales value of Woolworths during the current financial year amounted to $60,868.40 million or $48.07 per share while the current market price of stock valued to $24.27 therefore, price to sales ratio equals to 1.98. Considering the price to sales ratio of other similar organizations in the same industry, trading value is 2.0, which is higher than that of the value of Woolworths(Asx.com.au 2017). Hence, the shares of Woolworths Limited can be considered as undervalued and are suitable if investors go long on such securities. However, if market capitalization factor is consider ed to determine the share valuation, it represents the value of entire securities of the company. It is measured by considering current price of each stock of the company as well as total number of outstanding shares. Moreover, enterprise value refers to the total value of the organization that is measured by considering market capitalization value and total value of debt involving short- term and long- term debts (Alti and Tetlock2014). As per the current financial report, market cap of the company has been 71.72B whereas enterprise value has been 76.31B hence it can be said that the stock price of Woolworths Limited is undervalued as the market capitalization is lower and the investors are recommended to go long. Conclusion Share valuation analysis is considered to be one of the essential factors for the investors to determine the organizational efficiency for the purpose of making investments. As the study demonstrates different models and methodology for valuation shares, it presents analysis on the overvaluation, undervaluation or correct valuation of shares for the selected company Woolworths Limited. For this purpose, absolute valuation method has been considered that incorporates dividend discount model, discounted cash flow method, growth rate method, earnings per share method. Following the dividend discount model, security valuation has been done based on the dividend paid by Woolworths over the several financial years along with comparison in the current year. As per the methodology, value of shares determined has been undervalued since the current market price of the security reflected lower value. Similarly share valuation as per discounted cash flow method, share valuation has been determined as undervalued because the value of share as per cash flow method has been higher than the market price. Further, share valuation as per other methodology has been determined as undervalued as the current market value of Woolworths security was lower. On the contrary, valuation based on the percentage of return on assets and growth rate considered to be overvalued since the standard return value has been higher. 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