Financial Analysis Of AMEX And VISA: A Comparison
Discussion
Financial Analysis is the process of the evaluating the asset class and the characteristics of the asset class depending on the type of the nature of the asset class and the risk return characteristic of the stocks. The stock valuation was done using the Gordon Growth Dividend Discount Model and the same was compared with the actual true market price of the stock. The valuation of the stock helped us determine whether they were undervalued or overvalued. The analyst view about the stocks opinion with the relation to the future prospects of the company was evaluated. The beta for the stocks was calculated and the same was determined using the regression analysis for evaluating the volatility in the stock (Liow & Ye 2017). The reason behind the true fair market value of the stock and the intrinsic market value was covered on the different assumptions and factors involved in the same. The assumptions behind the capital market theory band the application of the same in the evaluation of the stocks and various other asset class were covered. Diversification plays an important role in the portfolio and the same was well discussed in the context of the assignment (Vivanco, Gonzalez & Martinez, 2018). The difference between the systematic and unsystematic risk and the influence of the same in the application of the portfolio analysis was the key factor involved in the assignment. There are various kinds of investment management strategy that are applied by the fund manager which are like applying the principles of technical and fundamental analysis in order to identify the potential of the asset class and derive the risk return strategy for the portfolio.
The Beta shows the volatility and the rate of the movement of the stock or the asset class with respect to the movement in the benchmark. The beta was determined for the AMEX and VISA stock using the historical share price data where S&P 500 Index was taken as the benchmark Index for calculating the beta of the stock. The beta analysis for the stock was taken into consideration so that the sensitivity of the stock with respect to the benchmark index could be better assessed and understood (Allen, Powell & Singh, 2015). The beta of the AMEX stock with the benchmark Index S&P 500 Index was quite high. The beta for the stocks was calculated using the ordinary lease square regression method where the market index return was taken as the independent variable and the returns on the stock was taken as the dependent variable. The beta of the AMEX stocks was around 1.69 times and the beta of the VISA stock with respect to the Market Index was around 0.80 times. High beta stock such as AMEX are highly volatile stocks which says that if the market index moves by 1 the stock is expected to move by 1.69 times.
Beta Analysis
The required rate of return for the stock was calculated using the Capital Asset Pricing Mode where the Required Rate of Return was derived using the formula:
Required Rate of Return (Re) = Risk Free Rate of Return + (Return on Market- Risk Free Rate of Return)*Beta.
The required rate of return for both stocks AMEX and VISA was calculated using the above formula. The risk free rate of return taken for the analysis of the same was the 10 Year Treasury Yield. The return on the benchmark index S&P 500 Index was taken as the return on market and the beta of each stock was determined in order to evaluate the required rate of return. The required rate of return on the AMEX stock was around 10.17% and the required rate of return on the VISA stock was around 6.48% respectively.
The Gordon Growth Model takes the forecasted dividend and the required rate of return to determine the intrinsic value of the share price of the company. The Gordon Growth Dividend Discount Model was applied in the case of VISA and AMEX shares were the intrinsic value for the shares were determined in order to calculate and evaluate the pricing of the stock. The formula used for determining the intrinsic value of the shares was:
Intrinsic Value (I.V) = (D1/(1+Re)+(D2/(1+Re)+(D3/(1+Re))+(D4/(1+Re))+(P4/(Re-g)).
The Gordon growth model was taken into consideration for determining the intrinsic value of the share and the above formula was used for determining the current intrinsic value of the share and the required rate of return was also use in the evaluation of the same. The intrinsic value of the AMEX share was derived as $27.84 and the value of the VISA share was determined as $242.85.
The intrinsic value of the shares was determined using the GGM model and the intrinsic price of the AMEX share was determined to be around $27.84 however the current market value of the share was around $112.89. The current market value of the share was currently high, which shows the overvaluation of the share in the current given market situation. The intrinsic value of the share for VISA share was evaluated to be around $242.85 and the market value of the share at same time was around $141.38 which shows that the stock is currently undervalued under the given market situation (Damodaran, 2016).
The Gordon growth model was used above to determine the intrinsic value of the share price and the same was done by forecasting the dividends for the company. The key factor involved in the valuation of the same was the usage of the forecasted dividend and the growth rate used for the valuation of the shares. The forecasted dividend was calculated using the average growth rate of the dividend in the five-year historical trend rate and the same was applied in the case of forecasted dividends. The key limitation identified in the application of the GGM model and determining the intrinsic value of the shares was the usage of the growth factor and the forecaster dividend, which are based on the assumptions of the analyst determining the true value of the shares (Jordan, 2014).
Required Rate of Return
The analyst opinion for the firm’s stock value has been dependent on the derived intrinsic value of the shares. The AMEX share was currently seen as overpriced when the same was compared with the true market value of the shares (Grant, 2016). The overvaluation of the AMEX share with the true market value of the share makes the stock unfavorable for the purpose of investment. However, the true market value for the VISA Inc. share was less than the intrinsic value determined for the shares, which makes the stock favorable for the purpose of investment. The undervaluation of the stock shows the stock potential for growing and outperforming (Joos, Piotroski, & Srinivasan, 2016).
The discrepancies between the computed and actual stock returns is mainly due to the opinion and assumptions used by the one for determining the prospects of the share and the value of the investment in the future for the company. The difference between the actual and the computed returns may also be on the ground of different factors such as the market forces, business conditions and the macroeconomic environment under which the company operates. The difference between the actual return may also been seen due to the different valuation models and the techniques applied by the investors depending on the growth prospect taken and forecasted for the company (Easton & Sommers, 2018). The common valuation techniques and tools used by the investors are the application of the Gordon Growth Model, Residual Income Valuation and the usage of the Free Cash flow model for determining the intrinsic value of the share (Duncan et al. 2017).
The main assumptions underlying the application of the Capital Market theory is that the investors are rational i.e., efficient investors. The investors follows the Markowitz Idea where the follow and apply the principles of investment based on the efficient frontier where the asset allocation between the market portfolio and the risk free asset is primarily based on the investors risk and return preference (Kock, Heising & Gemünden, 2015). The investment goals and objectives and the risk return characteristic help the investors identify the amount of investment and the allocation of the investible amount between the Cash and Market Portfolio (Charbonneau et al. 2016).
A diversified portfolio is one where the unsystematic risk in the portfolio is reduced by investing the portfolio amount into various kind and categories of assets so that the unsystematic risk of the portfolio is reduced. A diversified portfolio is one where the investible amount is diversified into various asset class so that risk and return derived from the same is modified. The risk and return from the portfolio are modified, as the weights of the stocks will be put according to the risk return profile of the asset class (Bollen, Joenväärä & Kauppila, 2018).
Gordon Growth Model
Portfolio with diversified stocks usually modifies the risk and return strategy and the same will create a better-diversified portfolio reducing the risk and return characteristics of the stocks. The portfolio will be created on the base of the different stocks, which will provide a risk diversification and return generation for the stocks (Auerbach, 2015). As such, there are no limitation on the number of stocks required for creation of a diversified portfolio but the number of stocks to be included in the portfolio should be based on the cost benefit analysis in the portfolio. However, the number of stocks required for a portfolio should at least be 5-6 stocks, which should be uncorrelated and should be from different industries and sectors (Campbell et al. 2018).
There are primary two common risk faced by the investors during the investment process, which are primarily systematic risk and unsystematic risk (McIntosh, Fitzgerald & Kirk 2017). Systematic risk is the type of risk, where the risk and return of the stock is dependent on the performance of the economy or the market risk, which is faced by the investors at the time of investing the same with the stocks. Systematic risk may be referred to the daily volatility faced by the investors, which may compose of the fluctuations in the stock price of the company. Generally, the systematic risk faced by the investors is non-diversifiable. However, the unsystematic risk is associated with the particular industry or sector faced by the stock. The unsystematic risk of the stock may be diversified by investing into various categories and types of stocks so that the risk and return from the portfolio are modified (Klingebiel & Rammer, 2014).
The Capital Market Line and the Security line are the two common graphical presentation, which are used and applied in the portfolio analysis. The Capital Market Line is a type of graphical representation that shows the relationship between the expected return on the portfolio risk and the risks, which are taken by the investors. However, the Security Market Line or the SML is the graphical representation that shows the relationship between the required return on the individual stocks after comparing the systematic risk and the non-diversifiable risk of a portfolio. The investors in the application of the portfolio analysis use both the graphical representation (Onyshko & Novitskyi, 2015).
The fundamental and technical analysis are the common investment strategies used by the portfolio fund managers for evaluating and assessing the various kinds of asset class. Fundamental Analysis for the stocks include assessing the stocks based on the background information of the company and the financial performance of the stocks (Satyanarayana & Naresh, 2015). The management of the company, profitability return generated by the stock are some of the common factors that are taken into consideration while evaluating the stock fundamentally. Technical Analysis is the identification of the investment strategy that are applied by the investors for identifying the trade opportunities by analyzing the statistical trends, charts, volume of the shares and other tools to determine and forecast the share price of the company. Forecasting of market prices and the study of the market prices of the data given for the company are some of the factors taken into consideration while conducting the technical analysis for the stock.
Comparison of Intrinsic and Market Value of the Shares
There are two common ways where the required rate of return for the stocks could be determined are by using:
- Capital Asset Pricing Model (CAPM): The Capital Asset Pricing model is the commo0n techniques used for determining the expected required rate of return. The formula used for determining the same is as follows:
Required Rate of Return (Re) = Risk Free Rate of Return + (Return on Market- Risk Free Rate of Return)*Beta (Barberis et al. 2015).
- Weighted Average Cost of Capital (WACC): The weighted average cost of capital for the firm is the other technique applied for the usage of determining the required rate of return from the stock (Chandra, 2017). The formula used for the same is as follow:
WACC: Weight of Equity*Cost of Equity+ Weight of Debt* Cost of Debt.
The current valuation for the AMEX and VISA shares were determined using the Gordon Growth Model and the same was determined in order to determine the undervaluation or the overvaluation of the share price of the company. The intrinsic price of the AMEX share was determined to be around $27.84 however the current market value of the share was around $112.89 which shows that the stock is currently overvalued and the same should be given with a “ Sell” recommendation for the stock. The revenue for the companies and the operating income for the companies is said to be decreasing and the future prospect of the company is said to be volatile showing a falling trend for the company. The economic conditions and the business factors for the stocks has been the key factor for the analysis of the same and the same is expected to be unfavorable for the stock. The intrinsic value of the share for VISA share was evaluated to be around $242.85 and the market value of the share at same time was around $141.38, which shows that the stock is currently undervalued and should be given a buy recommendation so that the investors can enjoy the future prospect of the company. The rising operating income for the company and the rising profitability of the company are some of the key factors, which shows that the future prospect of the company looks favorable.
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