Although neither sibling wants to sell, they have decided they should value their holdings in the company. To get started, they have gathered the following information about their main competitors:
Expert HVAC Corporations negative earnings per share were the result of an accounting write-off last year. Without the write-off, earnings per share for the company would have been $0.54.
Last year, Ragan, Inc., had an EPS of $4.85 and paid a dividend to Carrington and Genevieve of $75,000 each. The company also had a return on equity of 17 percent. The siblings believe that 14 percent is an appropriate required return for the company.
Ragan, Inc. Competitors
1. Assuming the company continues its current growth rate, what is the value per share of the companys stock?
Total dividend= (75000—2) = $150000
Total earning= (50000—4.85) = $242500
Payout ratio= 150000/242500= .62
Retention ratio= (1-.62) = .38
g= ROExb= .17x.38= .065 or 6.5%
P0= D1/(Ke-g)= (1.5—1.14)/(.14-.065)= $22.8
2. To verify their calculations, Carrington and Genevieve have haired Josh Schlessman as a consultant. Josh was previously an equity analyst and covered the HVAC industry. Josh had examined the companys financial statements, as well as those of its competitors. Although Ragan, Inc., currently has a technological advantage, his research indicates that other companies are investigating methods to improve efficiency. Given this, Josh believes that the companys technological advantage will last only for the next five years. After that period, the companys growth will likely slow to the industry growth average. Additionally, Josh believes that the required return used by the company is too high. He believes the industry average required return is more appropriate. Under this growth rate assumption, what is your estimate of the stock price?
Industry EPS= (.84+1.43+.54)/3= .91
Industry Payout ratio= .49/.91= .54
Industry retention ratio= 1-.54= .46
g= 15x.46= 6.9%
D6= 1.5—1.14^6= 3.2925
Stock price in year 5 with the Industry rate of return
= 3.2925/ (.1167-.069) = $69.02