In this chapter we described the various factors that influence stock prices and the approaches analysts use to estimate a stock's intrinsic value. By comparing these intrinsic value estimates to the current price, an investor can assess whether it makes sense to buy or sell a particular stock. Stocks trading at a price far below their estimated intrinsic values may be good candidates for purchase, whereas stocks trading at prices far in excess of their intrinsic value may be good stocks to avoid or sell.

Although estimating a stock's intrinsic value is a complex exercise that requires reliable data and good judgment, we can use the data available in Thomson ONE to arrive at a quick "back of the envelope" calculation of intrinsic value.

1. For purposes of this exercise, let's take a closer look at the stock of ExxonMobil Corporation (XOM). Looking at the COMPANY OVERVIEW, we can immediately     see the company's current stock price and its performance relative to the overall market in recent months. What is ExxonMobil's current stock price? How has the stock performed relative to the market over the past few months?
2. Click on the "NEWS" tab to see the recent news stories for the company. Have there been any recent events affecting the company's stock price, or have things been relatively quiet?
3. To provide a starting point for gauging a company's relative valuation, analysts often look at a company's price-to-earnings (P/E) ratio. Returning to the COMPANY OVERVIEW page, you can see XOM's current P/E ratio. To put this number in perspective, it is useful to compare this ratio with other companies in the same industry and to take a look at how this ratio has changed over time. If you want to see how XOM's P/E ratio stacks up to its peers, click on the tab labeled PEERS. Click on FINANCIALS on the next row of tabs and then select KEY FINANCIAL RATIOS. Toward the bottom of the table you should see information on the P/E ratio in the section titled Market Value Ratios. Toward the top, you should see an item that says CLICK HERE TO SELECT NEW PEER SET-do this if you want to compare XOM to a different set of firms.
For the most part, is XOM's P/E ratio above or below that of its peers? Off the top of your head, can these factors explain why XOM's P/E ratio differs from its peers?
4. To see how XOM's P/E ratio has varied over time, return to the COMPANY RATIOS and then OVERVIEW page. Next click FINANCIALS-GROWTH select WORLDSCOPE-INCOME STATEMENT RATIOS. Is XOM's current P/E ratio well above or well below its historical average? If so, do you have any explanation for why the current P/E deviates from its historical trend? On the basis of this information, does XOM's current P/E suggest that the stock is undervalued or overvalued? Explain.
5. In the text, we discussed using the dividend growth model to estimate a stock's intrinsic value. To keep things as simple as possible, let's assume at first that XOM's dividend is expected to grow at some constant rate over time. Then its intrinsic value would equal D₁/(r, - g), where D, is the expected annual dividend 1 year from now, r, is the stock's required rate of return, and g is the dividend's constant growth rate. To estimate the dividend growth rate, it's helpful first to look at XOM's dividend history. Staying on the current Web page (WORLDSCOPE INCOME STATEMENT RATIOS), you should immediately find the company's annual dividend for the past several years. On the basis of this information, what has been the average annual dividend growth rate? Another way to obtain estimates of dividend growth rates is to look at analysts' forecasts for future dividends, which can be found on the ESTIMATES tab. Scrolling down the page, you should see an area marked Consensus Estimates and a tab under Available Measures. Here you click on the down arrow key and select Dividends Per Share (DPS). What is the median year-end dividend forecast? You can use this as an estimate of D, in your measure of intrinsic value. You can also use this forecast along with the historical data to arrive at a measure of the forecasted dividend growth rate, g.
6. The required return on equity, r, is the final input needed to estimate intrinsic value. For our purposes you can either assume a number (say, 8% or 9%) or use the CAPM to calculate an estimated cost of equity using the data available in Thomson ONE. (For more details, take a look at the Thomson ONE exercise for Chapter 2). Having decided on your best estimates for D₁, rs, and g, you can then calculate XOM's intrinsic value. How does this estimate compare with the current stock price? Does your preliminary analysis suggest that XOM is undervalued or overvalued? Explain.
7. Often it is useful to perform a sensitivity analysis, in which you show how your estimate of intrinsic value varies according to different estimates of D₁, Is, and g. To do so, recalculate your intrinsic value estimate for a range of different estimates for each of these key inputs. One convenient way to do this is to set up a simple data table in Excel. Refer to the Excel tutorial accessed through the textbook's Web site for instructions on data tables. On the basis of this analysis, what inputs justify the current stock price?
8. On the basis of the dividend history you uncovered in question 5 and your assessment of XOM's future dividend payout policies, do you think it is reasonable to assume that the constant growth model is a good proxy for intrinsic value? If not, how would you use the available data in Thomson ONE to estimate intrinsic value using the nonconstant growth model?
9. Finally, you can also use the information in Thomson ONE to value the entirecorporation. This approach requires that you estimate XOM's annual free cashflows. Once you estimate the value of the entire corporation, you subtract thevalue of debt and preferred stock to arrive at an estimate of the company's equity value. Divide this number by the number of shares of common stock outstanding, which yields an alternative estimate of the stock's intrinsic value. Thisapproach may take some more time and involve more judgment concerningforecasts of future free cash flows, but you can use the financial statementsand growth forecasts in Thomson ONE as useful starting points. Go to Worldscope's Cash Flow Ratios Report (which you find by clicking on FINANCIALS, FUNDAMENTAL RATIOS, and WORLDSCOPE RATIOS) to findan estimate of "free cash flow per share." Although this number is useful,Worldscope's definition of free cash flow subtracts out dividends per share;therefore, to make it comparable to the measure used in this text, you mustadd back dividends. To see Worldscope's definition of free cash flow (or anyterm), click on SEARCH FOR COMPANIES from the left toolbar and thenselect the ADVANCED SEARCH tab. In the middle of your screen, on theright-hand side, you will see a dialog box with terms. Use the down arrow toscroll through the terms, highlighting the term for which you would like to seea definition. Then, click on the DEFINITION button immediately below thedialog box.