Chris Norton is a young Hollywood writer who is well on his way to television superstardom. After writing several successful television specials, he was recently named the head writer for one of TV’s top-rated sitcoms. Chris fully realizes that his business is a fickle one and, on the advice of his dad and manager, has decided to set up an investment program. Chris will earn about a half-million dollars this year. Because of his age, income level, and desire to get as big a bang as possible from his investment dollars, he has decided to invest in speculative, high-growth stocks.
Chris is currently working with a respected Beverly Hills broker and is in the process of
building up a diversified portfolio of speculative stocks. The broker recently sent him information on a hot new issue. She advised Chris to study the numbers and, if he likes them, to buy as many as 1,000 shares of the stock. Among other things, corporate sales for the next 3 years have been forecasted as follows:
Year .... Sales
($ in millions)
1 ..... 22.5
2 ..... 35.0
3 ...... 50.0
The firm has 2.5 million shares of common stock outstanding. They are currently being traded at $70 a share and pay no dividends. The company has a net profit rate of 20%, and its stock has been trading at a P/E of around 40 times earnings. All these operating characteristics are expected to hold in the future.
a. Looking first at the stock:
1. Compute the company’s net profits and EPS for each of the next 3 years.
2. Compute the price of the stock 3 years from now.
3. Assuming that all expectations hold up and that Chris buys the stock at $70, determine his expected return on this investment.
4. What risks is he facing by buying this stock? Be specific.
5. Should he consider the stock a worthwhile investment candidate? Explain.
b. Looking at Chris’s investment program in general:
1. What do you think of his investment program? What do you see as its strengths and weaknesses?
2. Are there any suggestions you would make?
3. Do you think Chris should consider adding foreign stocks to his portfolio? Explain.