CASE: VALUING WAL-MART STOCK
1. Purpose of valuation of Wal-Mart stock
In January 2006, Rachel Martin, an investment advisor, was examining the Wal- Mart stock to establish its value so as to recommend to her new clients and to convince the existing clients to maintain the Wal-Mart stock in their portfolios.
2. Synopsis of Wal-Mart Stores, Inc. (hereafter Wal-Mart)
Wal-Mart became publicly traded company in 1970. In January 2006, the stock price was $ 49.47, however analyst had projected the price to be $ 55.45. Thus the Wal-Mart stock was underpriced. In the year 2005, the Wal-Mart price range was a low of $42.33 and a high of $ 54.60.
Martin wished to apply the Dividend Discounting Model, the Capital Asset Pricing Model (CAPM) and the Price /Earnings Ratio Multiple as approaches to estimate the potential market price of Wal-Mart.
3. Application of Dividend Discounting Model
Dividend Discounting Model estimate the price of a stock by dividing the anticipated dividends per share by the investor’s required rate of return after deducting the growth of dividends. ( P0= Edps/ rrr-g, where Po is the estimated stock price, Edps is the forecasted dividends per share, rrr is the investor’s required rate of return and g is the growth in dividends.
Based on information on Capital Asset Pricing Model, we can estimate the required rate of return (rrr) . The 10 year bond had a yield of 4.4%. The USA estimated market risk premium( return of market – risk free rate ) was 5.05%. Consequently an estimate of the expected retrun of Wal- Mart retrun would be estimated from the following CAPM :
Erj= Rfr+ ßj( Rm-Rfr) where Erj is the expected return of security j, Rfr is the risk freee rate estimated from 10 year bond, ßj is the market risk of Wal- Mart , as estimated by Bloomberg