You are to analyze and compare one company from the holdings to another company that the Fund does not currently own within the same sector. (USB, PNC). Your analysis will include both fundamental and technical analysis.
For the fundamental analysis, you are to calculate the intrinsic value of each company's (USB, PNC) stock using the constant-growth model. Use an average growth trend in past dividends to estimate "g", and use the CAPM to estimate "k" (use the 10-year T-Note for the risk-free rate and 12% as the expected return on the market). Briefly explain any assumptions being made and interpret your results.
I have the technical analysis part done, I just cannot figure out the fundamental analysis. Your help is greatly appreciated. Thanks
To calculate the intrinsic value of each company's stock using the constant-growth model, you will need to determine the growth rate (g) and the required rate of return (k).
Step 1: Calculate the growth rate (g)
To estimate the growth rate, you can use the average growth trend in past dividends. This assumes that the dividends have been growing steadily over time and will continue to do so in the future. Calculate the average annual growth rate of dividends for both USB and PNC over a specific period (e.g., 5 or 10 years).
The formula to calculate the growth rate is:
g = (Dividend in Current Year - Dividend in Previous Year) / Dividend in Previous Year
Step 2: Calculate the required rate of return (k)
To estimate the required rate of return, you can use the CAPM (Capital Asset Pricing Model). You will need the risk-free rate (usually the yield of a 10-year Treasury Note) and the expected return on the market.
The formula to calculate the required rate of return using CAPM is:
k = risk-free rate + beta * (expected return on the market - risk-free rate)
Note: You need to have beta values for USB and PNC to calculate the required rate of return. Beta quantifies a stock's sensitivity to market movements. If you do not have the beta value, you can research it or use a proxy value from a similar company in the same sector.
Step 3: Calculate the intrinsic value
Once you have the growth rate (g) and the required rate of return (k) for both USB and PNC, you can use the constant-growth model to calculate the intrinsic value of their stocks.
The formula for the constant-growth model is:
Intrinsic Value = Dividend per Share / (Required Rate of Return - Growth Rate)
Assumptions to consider:
1. The constant-growth model assumes that the dividends will continue growing at a constant rate into the future. This assumption may not hold true if the company's growth rate changes significantly or if it stops paying dividends.
2. The CAPM assumes that the market is efficient and that investors are rational. However, market conditions and investor sentiment can vary.
Interpreting the results:
Compare the calculated intrinsic value of each company's stock with its current market price. If the intrinsic value is higher than the market price, it suggests that the stock may be undervalued and could be a potential investment opportunity. Conversely, if the intrinsic value is lower than the market price, it may indicate that the stock is overvalued.
Remember that fundamental analysis is just one aspect of evaluating a company's stock. It should be used in conjunction with other factors, such as the company's financial health, competitive position, industry trends, and management quality, to make informed investment decisions.