Real Vision Investment Case Study

Transcription

1 Image Source: ieplexus Real Vision Investment Case Study The Economist Case Study Competition 2016 Presented By: Team Precision Jorge Gaspar Chris Gillespie Allysa Kiedpool November 9, 2015

2 Contents 1. Introduction Key Figures Stock Valuation Amazon Expected Value Wal-Mart Expected Value Price/Earnings (P/E) Ratio: Recent Sales Recent Earnings Per Share Debt Ratios Portfolio Structure Overview of Investment Strategy Wal-Mart Stores Inc. Stock as an Investment Amazon.com Inc. as an Investment Recommendation of Investment Strategy SWOT Analysis Amazon SWOT Analysis Internal Strengths Internal Weaknesses External Opportunities External Threats Wal-Mart SWOT Analysis Internal Strengths Internal Weaknesses External Opportunities External Threats Conclusion Appendix i

3 1. Introduction As a rule of thumb, ordinary investors are told by professionals to purchase the stocks of companies that they regularly use. The reason behind this simple strategy is the assumption that there is some value the investors, and the masses, derive from the companies they regularly use. Thus, those companies are doing something right. This paper takes that qualitative reasoning deeper with both Amazon.com Inc. and Wal-Mart Stores Inc. What would be the reasons someone may invest in either of these two companies? Some quantitative calculations of the financial situation of both companies will help shed a bit of light on their current situations, but what about the next ten years? What stock would be a better investment if investors had to hold on to the stock for the next ten years? Those questions, and more, are answered in the following sections. 2. Key Figures There are several key figures that are used to help investors evaluate stocks. The following section provides an analysis of the stock value and financial health of both Amazon.com Inc. and Wal-Mart Stores Inc Stock Valuation Calculating the intrinsic value of a stock can be easy if the right data is available. For investors, knowing the true value of stocks versus the market value of stocks, can give a clear picture on whether or not a stock is under or overvalued. With that information, it's easier to decide if a specific stock should be invested in, shorted, or avoided altogether? Difficulty with calculating the intrinsic value enters the picture when specific data is not available for one reason or another. Alternative methods are available for such situations, as is the case with Amazon.com Inc. Page 1

4 Amazon Expected Value A basic way to calculate the intrinsic value of a stock is by first using the Capital Asset Pricing Model (CAPM) 1 approach to calculate the expected return of a stock. The basic data needed for the CAPM calculation are the expected return of the market, the risk free rate, and the beta of the stock the calculation will be for. Expected Return = R f + (R m -R f )*b The next step in working towards calculating the intrinsic value is to use the Constant Growth Model, also known as the Gordon Model. In order to complete the calculation for the Gordon Model, the dividend growth rate, the dividend of amount of the next period, and the expected return of the stock are all needed. Intrinsic Value = Where: D 1 = Dividend Amount for the Next Period k = Expected Return of the Stock g = Dividend Growth Rate As mentioned, Amazon.com Inc. stock requires an alternative method to calculate the true value. The reason for this is because Amazon has never paid out a dividend to shareholders. As a result, the Gordon Model is rendered useless for Amazon s stock calculation. An alternative method is called P/E Multiple 2. This method requires the current price to earnings (P/E) ratio and the forecasted earnings per share (EPS) for the next period. In this case, Amazon s current P/E ratio (as of Q3), is The forecasted EPS for Q4 is $ The product of the two delivers a stock price valuation of $1, per share. 1 Parwar, Anil, Fundamentals of Finance, Pearson Parwar, Anil, Fundamentals of Finance, Pearson Page 2

5 Intrinsic Value = P/E Ratio * Forecasted EPS Intrinsic Value = * 1.63 The price per share of Amazon.com Inc. s stock at market closing on Friday November 6 th, 2015 was $ This would indicate Amazon.com Inc. s stock is greatly undervalued in the marketplace Wal-Mart Expected Value Wal-Mart Stores Inc. stock is a different story, and can be calculated the traditional way, explained earlier, by using the CAPM and Gordon s Model. The S&P return is used to calculate the expected market return of 14.04% 4. The 10 year Treasury bond is used as the risk free rate at 2.33% 5. The beta of Wal-Mart Stores Inc. stock is averaged using five sources at CAPM expected return on the stock is calculated below. Expected Return = ( )* Expected Return = 9.52% The dividend growth rate for Wal-Mart Stores Inc. stock is calculated using the past five years of dividends, which calculated an average annual growth rate of 6.07% 6. The expected dividend one year from now is calculated by multiplying the current year s dividend ($1.96) by 1 + dividend growth rate, which yields a calculation of $2.08 per share. Using the expected rate of return for Wal-Mart s stock, calculated using CAPM, the Gordon s Model is now used to calculate the intrinsic value of the stock. Intrinsic Value = Intrinsic Value = $60.27 per share Page 3

6 The price of Wal-Mart Stores Inc. stock at closing on Friday November 6 th, 2015 was $58.78 per share. The stock, according to the CAPM and Gordon s model is slightly undervalued, but relatively close to the market valuation Price/Earnings (P/E) Ratio: The investor should also evaluate the company s financial statements. Revenue growth is a good indicator there is a chance as the revenues grow; the stock price will increase as well. The P/E Ratio shows how much investors will be willing to pay for every dollar of profits reported. The P/E ratio is calculated using the formula below 7 : P/E Ratio = Amazon P/E Ratio(as of 30-Sep-2015) = 8 9 = Wal-Mart P/E Ratio (as of 31-Jul-2015) = = Relatively high P/E ratios indicate strong growth for the firm and little risk. Amazon s high P/E ratio could be due to the fact that they always reinvest its earnings into the company for future growth Recent Sales Looking at the P/E ratio alone was insufficient in evaluating Amazon and Wal-Mart stock. The graphs below will show Amazon annual sales from 2010 to 2014 and Wal-Mart s annual sales from 20101to Also included in the graph is the sales growth rate year over year. As per Figure 1 and Figure 2 below, both Amazon and Wal-Mart have increased sales year over year. 7 Brigham, Eugene F., and Houston, Joel F,. Fundamentals of Finance, South-Western Cengage Learning, Page 4

7 Both companies have increased sales growth since 2011, however, Amazon s sales growth were increased in double digit percentages. From 2013 to 2014, Amazon s sales growth was 19.52% and Wal-Mart s sales growth was 1.52%. It is clear that when it comes to earning billions of dollars, Amazon is the clear winner with a sales growth of 19.52% from 2013 to Amazon Sales (In Billions), Fiscal Years ( ) $ % $80.00 $ % 30.00% $ % $ % $ Sales (In Billions) Sales Growth 0.00% Source: Figure 1. Amazon Sales Wal-Mart Sales (In Billions), Fiscal Years ( ) $ $ $ $ $ $ $ $ $ $ $ $ Sales (In Billions) Sales Growth 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Source: Figure 2. Wal-Mart Sales Page 5

8 2.4. Recent Earnings Per Share EPS serves as an indicator of a company s profitability, which makes EPS an important figure for investors. The EPS is portion of a company s profit that is allocated to each outstanding share of common stock 12. EPS is also known as the bottom line, which refers to all of the items on the income statement. Figure 3 below shows Amazon and Wal-Mart s EPS through fiscal years Q through Q Analysts initially estimated a loss for Amazon at the end of Q3. However, Amazon exceeded EPS estimates and reported positive earnings instead of a loss. Amazon is expected to increase revenue by 20% and recently announced hiring 100,000 temporary seasonal employees 13. Wal-Mart s EPS increased by 4.85% from Q2 to Q3, however, it is expected to decrease in the current fiscal year and to continue to decrease through The drop in earnings is due to Wal-Mart s plans to invest in people and technology Amazon & Wal-Mart EPS, Q Q Q Q Q Q Q Amazon EPS Wal-Mart EPS Source: Figure 3. Amazon & Wal-Mart EPS Page 6

9 2.5. Debt Ratios The debt ratio is a financial measure of the company s leverage. It measures the percentage of funds that are funded by creditors 15. A higher debt ratio indicates that the company has more leverage and may imply a higher financial risk. Debt ratios over 100% can be a result of a company having more debt than assets 16. The debt ratio is calculated by dividing total debt by total asset as per the equation below 17 : Debt Ratio = Amazon Debt Ratio (as of 30-Sep-2015) 18 = = 62.07% Wal-Mart Debt Ratio (as of 31-Jul-2015) 19 = = 52.28% Although Amazon has a higher debt ratio than Wal-Mart, debt can be a necessity for a growing company. Amazon has many plans to expand its brand. Amazon is currently testing out their first brick-and-mortar storefront which opened on November 3, 2015 in Seattle, Washington 20. Amazon recently spearheaded commercial drone testing and received permission for testing 21. Amazon has recently made strong moves into the exclusive and original content market, by signing on former Top Gear presenters to produce a new car show of 36 episodes for $250 million on Amazon Prime streaming. Amazon has also recently started to offer offline access to its videos to its member on Android or ios, something that no other streaming service offers. Amazon also acquired Twitch.tv which is the primary streaming platform for e-sports. A budding industry with estimated 113 million e-sports enthusiasts and 147 million casual viewers, 15 Brigham, Eugene F., and Houston, Joel F,. Fundamentals of Finance, South-Western Cengage Learning, Brigham, Eugene F., and Houston, Joel F,. Fundamentals of Finance, South-Western Cengage Learning, Page 7

10 the e-sports global market is set to bring in more than $250 million in revenue in In 2014, Twitch claimed a 43 percent share of the $3.8 billion video game content market 23. Wal-Mart announced their plans to spend $2 billion on e-commerce in order to catch up and compete with Amazon 24. Wal-Mart recently asked the Federal Aviation Administration for permission to test drone delivery as well 25. Wal-Mart has made feeble attempts to enter the streaming market with Vudu as well as attempting to enter the online marketplace. Even if Wal- Mart penetrates the e-commerce market successfully it is miles away from rivaling Amazon in the lucrative field of online streaming. In addition, although Wal-Mart has a lower debt ratio than Amazon, these investments plans may cause its debt ratio to increase in the near future. 3. Portfolio Structure 3.1. Overview of Investment Strategy Wal-Mart Stores Inc. and Amazon.com Inc stocks are both solid performers, respectively. Deciding the structure a portfolio if an investor had to pick one of the two stocks for a period of 10 years is not an easy decision. Any Certified Financial Planner would need to determine the risk aversion associated with that client. There is not a clear cut solution to the problem Wal-Mart Stores Inc. Stock as an Investment Wal-Mart has been a solid investment since the mid 1970's. They are, and remain, a good large cap stock to hold in a portfolio. The stock has a dividend growth rate of just over 6%, which can Page 8

11 be attractive to many investors. The stock itself can act as a major long run stabilizing force for any portfolio Amazon.com Inc. as an Investment Amazon.com Inc. has shown tremendous innovation and stock growth since their inception in the late 1990's. Amazon currently has a much higher potential for growth, but has never paid a dividend to shareholders, and doesn't appear to have plans to change this any time soon. Amazon continues to innovate and reinvest in the company which is a good reason to not pay dividends. Along with the great growth potential, volatility accompanies the stock. Amazon.com Inc.'s beta is on average, 2.5 times higher than the stable Wal-Mart beta of Recommendation of Investment Strategy An intelligent investment strategy would be to invest into Amazon stock and not purchase bonds that are routinely offered by the company. Amazon s leadership has shown the willingness to take on exciting new projects. Some have been successful, and others not so successful. Nevertheless, they have very capable and intelligent leadership at the helm and show no signs of slowing down. The stock itself has grown incredibly quick over the past 20 years, and the analysis performed shows it is still undervalued in the marketplace. Amazon has proven itself to be a global leader in innovation of new services and products. The potential for continued success is immeasurable. It would be highly advised to add and retain the Amazon.com Inc. stock for a long term, high growth strategy component of a well balanced portfolio. 4. SWOT Analysis The next section focuses on providing a SWOT analysis of Amazon and Wal-Mart. The analysis highlights the discernible difference between the two companies. Page 9

12 External Internal 4.1. Amazon SWOT Analysis Strengths Weaknesses Customer Base Shrinking Profit Margins Available Capital High Debt Data Collection Multiple Recent Product Flops Strategic Alliances Recent Tax Avoidance Issues Delivery Network GLOCAL Strategy Strategic Acquisitions Diversified Products Opportunities Threats Global Expansion Low Entry Barriers Product Creation/In-House Brands Government Regulations Acquisition Opportunities Local Competition Physical Stores IT Threats Acquisition Opportunities Lawsuits Internal Strengths Customer Base: good brand awareness. Available Capital: can take on diverse projects. Data Collection: can offer products based on consumers shopping preferences. Strategic Alliances: logistics providers to control costs. Delivery Network: provides efficient delivery. GLOCAL (go-global and act-local) Strategy: used to expand to international markets. Strategic Acquisitions: such as Zappos.com and Twich.tv to keep be diversified. Diversified Products (non-ecommerce): streaming service, Kindle, and Fire products Internal Weaknesses Shrinking Profit Margins: due to the delivery network and price wars from competitors. Page 10

13 High Debt Multiple Recent Product Flops Tax Avoidance Issues External Opportunities Global Expansion: opportunities for global expansion from GLOCAL strategy. Product Creation and In-House Brands: in-house brands in different product categories. Physical Stores: outside the U.S. Acquisition Opportunities: to maintain competitive edge External Threats - Low Entry Barriers: leads to more competitors equals even less profit margins. - Government Regulations: may threaten the way Amazon does business. - Local Competition: in global markets. - IT Threats: security and safety concerns. - Lawsuits: for price gauging. Page 11

14 External Internal 4.2. Wal-Mart SWOT Analysis Strengths Weaknesses Integrated IT Systems Thin Profit Margins Acquisitions in UK and India Employee Issues Customer Base / Brand Loyalty International Penetration Low Prices Brand is Associated With Low Quality Wide Product Selection Opportunities Threats Expansion to Untapped Markets Increased Competition Online Marketplace Growth Demand For Higher Quality Products Inclusion Of Other Services Concern About Ethics Strategic Acquisitions Big Box Store Issues Internal Strengths Integrated IT Systems: with international logistics system. Acquisitions in UK and India: company growth and expansion in the form of new stores and acquisitions of major retailers in the UK and India. Customer Base/Brand Loyalty: well recognized brand/customer loyalty. Low Prices: due to buying in large volumes. Wide Product Selection: keep the consumer in one place Internal Weaknesses Thin Profit Margins: keep prices lower than competitors. Employee Issues: turnover and dissatisfaction. International Penetration: relatively small. Brand: name of the brand is synonymous with low quality. Page 12

15 External Opportunities Expansions to Untapped Markets: focus on potential expansion into untapped markets. Online Marketplace Growth: online shopping integration with physical stores. Inclusion of Other Services: from forging of strategic partnerships. Strategic Acquisitions: smaller companies to further their business plan External Threats Increased Competition: in both the retail market and the inexpensive dollar store market. Demand for Higher Quality Products: high demand for organic and locally grown produce has shoppers going to smaller local retailers for their grocery needs which results in smaller profit margins. Concern about Ethics: Increased concern on the company s ethical position on a variety of topics such health care coverage. Big Box Stores Issues: stores are not well received in the US and across other international markets. Based on the SWOT analysis, Amazon s strength lies not just in its e-commerce division but in its online streaming service as well. There is a growing trend of cord-cutters who are cancelling their cable providers and switching to a Web-based service streaming service and 44% of the time these consumers are picking Amazon Prime 26. An article on Equities.com 26 Page 13

16 recently said that, Amazon is a unique integrated streaming service that can rival Netflix 27. Amazon has a firm second place behind Netflix with a market share 13% up from 3% from , and is poised to take advantage on the booming industry. The projected revenue from online video streaming is staggering. A recent article 29 mentions that annual revenues from video streaming and downloads are expected to grow by more than $6 billion between 2014 and Figure 4. Projected Video Streaming Revenue Page 14

17 5. Conclusion Based on the expected value calculations, the market is undervaluing the stock of Amazon. Wal- Mart s stock price was calculated in line with market valuation. Wal-Mart needs to diversify its product in order to compete with the diversification of Amazon. They are already investing heavily in e-commerce and had a small, unsuccessful foray into the streaming market. Amazon has already transformed ubiquity into a form of profit. They re-invest their revenue back into the company further advancing their omnipresence throughout both the real world and the internet. Therefore, profitability is not all that matters in a company. Maybe in years past, profitability was the only marker of a company s success, but in today s virtual age there are multiple factors to be considered when looking to invest long-term in a company. A solid strategy and vision for the company seem to be equally as important as profits. The recommendation for any investor looking for long term rewards would be to invest in Amazon stock. Page 15

18 6. Appendix Wal-Mart Beta Information: Beta Source Yahoo 0.82 Morning Star 0.82 Nasdaq 0.71 Rueters 0.29 Google 0.43 Avg Page 16