Building Blocks for a Valuation: General Electric Co. (Medium)

General Electric Co. reported a per-share book value of $10.47 in its balance sheet on December 31, 2004. In early 2005, analysts were forecasting consensus earnings per share of $1.71 for 2005 and $1.96 for 2006.

a. Calculate the value per share in early 2005 with a forecast that residual earnings will grow at a long-term growth rate of 4 percent, the average GDP growth rate, after 2006.

b. General Electric traded at $36 per share in early 2005. Construct a building block diagram, like that in Figure 5.5, displaying the components of this $36 price that are attributable to book value, short-term earnings expectations, and speculation about long-term growth.

c. What is the forecast of the residual earnings growth rate after 2006 that is implied by the

$36 market price?

d. What are the forecasts of earnings growth rates for 2007 and 2008 that are implied by the $36 market price? Assume that the firm’s dividend payout ratio of 50 percent will be maintained after 2006.