Estimating Exxon Mobil's Intrinsic Stock Value

Overview

In this chapter we described the various factors that influence stock prices. We also described a couple of approaches that analysts use to estimate a stock's intrinsic value. By comparing these estimates of intrinsic value 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 a lot of reliable data and good judgment, we can use the data available in Thomson Analytics to help come up with a quick "back of the envelope" calculation of intrinsic value.

Discussion Questions

1. For purposes of this exercise, let's take a closer look at the stock of Exxon Mobil Corporation (XOM). Looking at the COMPANY OVERVIEW we can immediately 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 the tab labeled NEWS to see the recent news stories for the company. Have there been any recent events that have had a major impact on 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 price-to-earnings (P/E) ratio. Returning back to the COMPANY OVERVIEW page, you can see XOM's current P/E ratio. To put this number in perspective, it is useful to compare this ratio to other companies in the same industry, and to take a look at how this ratio has changed over time. If you want to see how XOM's P/E ratio stacks up compared to its peers, click on the tab labeled PEERS. Click on FINANCIALS on the next row of tabs and then select KEY FINANCIAL RATIOS. Towards the bottom of the table you should see information on the P/E ratio in the section titled Market Value Ratios. Towards the top, you should see an item where it says CLICK HERE TO SELECT NEW PEER SET - do this if you want to compare XOM to a different set of firms. For the most part, is XOM's P/E ratio above or below that of its peers? In Chapter 3, we discussed the various factors that may influence P/E ratios. Off the top of your head, can these factors explain why XOM's P/E ratio differs from its peers?

4. Now to see how XOM's P/E ratio has varied over time - return back to the COMPANY OVERVIEW page. Next click FINANCIALS - GROWTH RATIOS and then select WORLDSCOPE - INCOME STATEMENT RATIOS. Is XOM's current P/E ratio well above or well below its historical average? If so, do you have any explanation for why the current P/E deviates from its historical trend? Based on all this information, does XOM's current P/E suggest that the stock is undervalued or overvalued?

5. In the text, we discussed at some length how you can you use the dividend growth 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 some constant rate over time. If so, the intrinsic value equals D1 / (ks - g), where D1 is the expected annual dividend one year from now, ks is the stock's required rate of return, and g is the dividend's constant growth rate. To estimate the dividend growth rate, it's first helpful to look at XOM's dividend history. Staying on the current webpage (WORLDSCOPE - INCOME STATEMENT RATIOS) you should immediately find the company's annual dividend over the past several years. Based on this information, what has been the average annual dividend growth rate? Another way to get estimates of dividend growth rates is to look at analysts' forecasts for future dividends. To see these forecasts, click on the tab labeled EARNINGS/ESTIMATES. Scrolling down the page you should see an area marked "Consensus Estimates" and a tab under "Available Measures". Here you click on the down arrow key and select, Dividends Per Share (DPS). What is the median year-end dividend forecast? You can use this as an estimate of D1 in your measure of intrinsic value. You can also use this forecast along with the historical data to arrive at a measure of the forecasted dividend growth rate, g.

6. The required return on equity, ks is the final input needed to estimate intrinsic value. For our purposes you can either assume a number (say 8% or 9%) or you can use the CAPM to calculate an estimate of the cost of equity using the data available in Thomson Analytics. (For more details take a look at the Thomson Analytics exercise for Chapter 5). Having decided on your best estimates for D1, ks, and g, you can calculate XOM's intrinsic value. How does this estimate compare to the current stock price? Does your preliminary analysis suggest that XOM is undervalued or overvalued?

7. 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, ks, and g. To do so, re-calculate 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 Microsoft Excel. In the Chapter 5 spreadsheet model found on the CD-ROM that accompanies the text, you will find an explanation of how to set up a data table. Refer to Row 265 of the model. Based on this analysis, what inputs does it take to justify the current stock price?

8. Based on the dividend history you uncovered in Question 5 above 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 Analytics to estimate intrinsic value using the non-constant growth model?

Finally note that you can also use the information in Thomson Analytics 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. Divide this number by the number of shares of common stock outstanding, and you get an alternative estimate of the stock's intrinsic value. While this approach may take some more time and involves more judgment concerning forecasts of future free cash flows, you can use the financial statements and growth forecasts in Thomson Analytics as useful starting points. Indeed, it turns out that if you go to Worldscope's Cash Flow Ratios Report (which you find by clicking on FINANCIALS/FUNDAMENTAL RATIOS and WORLDSCOPE RATIOS) there is an estimate of "free cash flow per share". While this number is useful, please note that Worldscope's definition of free cash flow subtracts out dividends per share - therefore in order to make it comparable to the measure in our text, you would need to add back dividends. To see Worldscope's definition of free cash flow (or any term), click on SEARCHING from the left toolbar, and select "Advanced Searching". You will now see an icon of a pair of binoculars toward the top right of the screen. Click on the binoculars and search through Worldscope's glossary of terms. Click on "Definition" to get an explanation of any terms.

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