NewsWire - January 17, 2000
Topic: The Role of Expectations in Stock Valuation
Source: "Street Seeks Real Thing on Coke Outlook," by Betsy
McKay, The Wall Street Journal, January 17, 2000, pages C1-C2.
Synopsis: Coca-Cola has experienced considerable volatility
and poor stock performance over the past two years. This follows a
lengthy period of robust growth in sales, earnings, and stock value.
This article details the role that analyst’s expectations play
in the valuation process. It also underscores the importance of
management credibility. Typically, we see the role of expectations in
valuation when a firm releases earnings figures that are materially
above or below the market’s (analysts’) expectations. The
value of the firm’s stock adjusts rapidly, evidence that markets
are highly efficient at incorporating new information into prices.
However, Coca-Cola raises a different issue. Their new chairman has
affirmed growth targets of 7% to 8% in sales volume and 15% to 20% in
earnings per share (EPS). Many analysts simply don’t think that
this is realistic. Without a credible forecast from management,
analysts are uncertain how to value Coke’s stock.
Discussion Questions:
- Why are expectations so important in the valuation of
stock? Why shouldn’t analysts accept the growth forecasts
provided by Coca-Cola’s management?
- If we accept management’s estimates of EPS growth and
assume that Coke’s payout ratio remains the same, estimate
the stock’s expected rate of return. Coke’s price is
$61.4375 and its dividend is $0.62 over the past year.
- Suppose investors require an 18% return for a security with
the risk level of Coke. Using the constant dividend growth model,
estimate the intrinsic value of the stock assuming a 15% to 20%
growth in dividends in 1% increments. What can you say about the
market’s assessment of dividend growth for Coke?
- How can an estimated growth in sales of 7% to 8% translate
into an estimate of 15% to 20% in EPS growth?
Return to news index.
|
