• Emerson Electric common stock that is selling for $80 with a par value of $5. This stock recently paid a $2.10 dividend, and the firm’s earnings per share have increased from $2.40 to $4.48 in the past 5 years. An equivalent amount of growth in the dividend is expected.
The required rate of return for the stock is 15%
The current annual dividend amounts to a 2.10/80 = 2.63% yield
The earnings growth at a rate of a factor of
4.48/2.40 = 1.8667 = (1+r)^5
amounts to appreciation in value at an annual rate given by
(1/5)ln(1+r) = ln 1.8667
r = 13.30%
The total return is 15.93%
The stock is fairly valued at $80 if a return of 15% is required
I personally would factor in risk as part of the return. For a stock which has an earnings growth of 13.3 percent, future competition and other factors surely presents a risk.
I failed to include the value of retained earnings, currently 5.6% of market price. (P/E ratio = 17.9; forward P/E = 15.8) This makes the stock somewhat attractive, but no great bargain, at $80. If one can believe the earnings trend will continue, it is fairly valued by historic P/E standards.
BobPursley is quite right however. Past performance is no guarantee of anything. Assessing risk is a very important part of investing.
They may want you to use some Benjamin Graham formula for Stock Valuation. I am no expert in that.
To determine the value of Emerson Electric common stock, we can use the Dividend Discount Model (DDM). The DDM is a valuation method that calculates the present value of future dividends to find the intrinsic value of a stock.
First, we need to calculate the expected dividend growth rate. The problem states that an equivalent amount of growth in the dividend is expected. Since the earnings per share have increased from $2.40 to $4.48 in the past 5 years, we can calculate the growth rate as follows:
Growth rate = (Current EPS - Previous EPS) / Previous EPS
= ($4.48 - $2.40) / $2.40
= 0.8667 or 86.67%
Next, we can use the Gordon Growth Model to calculate the intrinsic value of the stock:
Intrinsic Value = Dividend / (Required Rate of Return - Dividend Growth Rate)
= $2.10 / (0.15 - 0.8667)
= $2.10 / 0.2833
= $7.41
Therefore, the intrinsic value of Emerson Electric common stock is $7.41.
Since the stock is currently selling for $80, it is overvalued compared to its intrinsic value. However, it's worth noting that stock prices are determined by various factors, including market sentiment and future expectations, so the current market price may not always reflect the intrinsic value calculated using the DDM.