Application of residual income model and dividend discount model in valuing stock price of An Phu irradiation joint-Stock company

Thị trường chứng khoán những ngày đầu năm 2018 đang khá sôi động. Chỉ số VN-index của Sở Giao dịch Chứng khoán HCM cuối năm 2017 cán mốc 984,24 điểm, thiết lập một mức cao mới trong 10 năm sau khi tăng tổng cộng 4% trong sáu phiên, tăng 48% so với cuối năm 2016. Việc định giá cổ phiếu luôn là một chủ đề mà các nhà đầu tư và các nhà phân tích quan tâm vì nhà đầu tư đưa ra quyết định đầu tư của mình phụ thuộc vào quan điểm và tầm nhìn vào cổ phiếu mà họ quan tâm. Trong bài này, tác giả lấy cổ phiếu APC của Công ty cổ phần chiếu xạ An Phú để làm ví dụ định giá cổ phiếu đầu năm 2018 thông qua hai mô hình: mô hình tăng trưởng cổ tức (DDM) và mô hình thu nhập thặng dư (RIM). Dữ liệu sử dụng được lấy từ các báo cáo tài chính đã kiểm toán từ năm 2013 đến năm 2016.

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CELEBRATE VIET NAM TEACHERS’ DAY 20/11/2018 Journal of Marine Science and Technology No. 56 – November 2018 51 APPLICATION OF RESIDUAL INCOME MODEL AND DIVIDEND DISCOUNT MODEL IN VALUING STOCK PRICE OF AN PHU IRRADIATION JOINT-STOCK COMPANY TRAN THI HUYEN The Faculty of Financial Management, Vietnam Maritime University Abstract Stock market at the beginning of 2018 is experiencing effervescent tradings. The benchmark index on the HCM Stock Exchange ended 2017 at 984.24 points, setting a new 10-year high after having rallied a total of 4 per cent in six sessions. The benchmark index has risen 48 per cent since the end of 2016. Estimating the value of a stock is always a hot topic that investors and analysts are interested in. The investos make decisions based on their views about value of interested stock. In this paper, the author takes the stock APC (AN Phu Irradiation joint-stock company) as an example in using Discounted Dividend Method (DDM) and Residual Income Method (RIM) to estimate the value of the company at the beginning of 2018. The data used to estimatre company’s profit and book value is extracted from audited financial reports from 2013 to 2016. Keywords: valuation method. APC. Tóm tắt Thị trường chứng khoán những ngày đầu năm 2018 đang khá sôi động. Chỉ số VN-index của Sở Giao dịch Chứng khoán HCM cuối năm 2017 cán mốc 984,24 điểm, thiết lập một mức cao mới trong 10 năm sau khi tăng tổng cộng 4% trong sáu phiên, tăng 48% so với cuối năm 2016. Việc định giá cổ phiếu luôn là một chủ đề mà các nhà đầu tư và các nhà phân tích quan tâm vì nhà đầu tư đưa ra quyết định đầu tư của mình phụ thuộc vào quan điểm và tầm nhìn vào cổ phiếu mà họ quan tâm. Trong bài này, tác giả lấy cổ phiếu APC của Công ty cổ phần chiếu xạ An Phú để làm ví dụ định giá cổ phiếu đầu năm 2018 thông qua hai mô hình: mô hình tăng trưởng cổ tức (DDM) và mô hình thu nhập thặng dư (RIM). Dữ liệu sử dụng được lấy từ các báo cáo tài chính đã kiểm toán từ năm 2013 đến năm 2016. Từ khóa: Phương pháp định giá, APC. 1. Introduction In financial markets, stock valuation is the method of calculating theoretical values of companies and their stocks. The main use of these methods is to predict future market prices, or more generally, potential market prices, and thus to profit from price movement In the view of fundamental analysis, stock valuation based on fundamentals aims to give an estimate of the intrinsic value of a stock, based on predictions of the future cash flows and profitability of the business. Fundamental analysis may be replaced or augmented by market criteria - what the market will pay for the stock, disregarding intrinsic value. These can be combined as "predictions of future cash flows/profits (fundamental)", together with "what will the market pay for these profits?" These can be seen as "supply and demand" sides - what underlies the supply (of stock), and what drives the (market) demand for stock? Today, many methods are used in practice. These include discounted cash flow to equity (DCF) calculations, dividend discount model calculations (DDM), price to earnings multiple (P/E) methods, price to book multiple (P/B) methods, and Residual income model (RIM). Each method has both pros an cons. The two most used methods are DDM and RIM. 2. Materials and Methods 2.1. RIM in value of a Common Stock Residual income method, RIM is an approach to equity valuation that formally accounts for the cost of equitycapital. Here, "residual" means in excess of any opportunity costs measured relative to the book value of shareholders' equity; residual income (RI) is then the income generated by a firm after accounting for the true cost of capital. Residual Income valuation has its origins in Edwards & Bell (1961), Peasnell (1982), and Ohlson (1995). The basic idea behind this approach is that a rate of return is required by investors from their resources which are under the management of the firm, provide compensation for their opportunity cost and account for the level of risk. This rate of return is considered the cost of equity and a formal equity cost has to be subtracted from net income. Again, for creating shareholder value, management should be capable of generating returns which is at least equal to this cost. Therefore, even if the income statement of a company reports a profit, it can be actually CELEBRATE VIET NAM TEACHERS’ DAY 20/11/2018 52 Journal of Marine Science and Technology No. 56 – November 2018 unprofitable economically. Thus, it is possible that a value may be negative in this case, even though it is positive when traditional discounted cash flow approach is applied. In residual income approach, a company’s stock value can be calculated as sum total of its book value and its expected future residual income’s present value which is discounted at cost of equity, r. the general formula is: where: xt+I : earning per share (EPS) at t + i bt+i : book value at t + i Advantages of the RI Model o Because terminal value is not as significant in the RI model when compared to other models, there may be greater certainty in the valuation. o The model is driven by publicly available accounting data. o The model does not require a dividend payment. o The model is not impacted by near term negative or unpredictable cash flows. o The model captures economic profit. Disadvantages of the RI Model o The model is vulnerable to accounting manipulation by company management. o The model requires that the analyst have sophisticated understanding of public financial reporting, as large adjustments to reported financials may be required. o Similar to the previous point, the model requires a clean surplus relationship. Appropriateness of RI Model o The RI model can be utilized when: the company does not pay dividends; free cash flows are expected to be negative; or when there exists a high level of uncertainty around the terminal value. 2.2. DDM in value of a Common Stock The dividend discount model (DDM) is a method of valuing a company's stock price based on the theory that its stock is worth the sum of all of its future dividend payments, discounted back to their present value. In other words, it is used to value stocks based on the net present value of the future dividends. The equation most widely used is called the Gordon growth model (GGM). It is named after Myron J. Gordon of the University of Toronto, who originally published it along with Eli Shapiro in 1956 and made reference to it in 1959. Their work borrowed heavily from the theoretical and mathematical ideas found in John Burr Williams 1938 book "The Theory of Investment Value." Much like a preferred stock, holders of common stock can also receive dividends. However, dividends on common stock are not guaranteed, nor are they a fixed amount from year-to-year. As such, we can value common stock using dividends over various time horizons. a. One-year Holding period Consider a one-year holding period, in this time frame, an investor will receive a dividend and the price of the common stock at the end of the one year, both discounted back by the rate of return on the common equity. We can calculate the value of the common stock as follows: Dividend + Price at the end of the year Common Stock = (1 )r b. Multiple-year holding period Given investors can hold a common stock for over a year, it is useful to value a stock over the investor's expected holding period. In this case, the DDM model can be used. CELEBRATE VIET NAM TEACHERS’ DAY 20/11/2018 Journal of Marine Science and Technology No. 56 – November 2018 53 c. Infinite Period DDM To value a common stock using the infinite period DDM, the calculation is simplified much like it is when valuing a preferred stock with infinite dividends. Where r= rate of return, g= growth rate d. Valuing the Common Stock of Companies with Supernormal Growth When valuing a common stock of a company which is experiencing significant growth, we take a similar approach to valuing the common stock with a multi-year holding period. The difference in the approaches is related to the dividend. A multi-year holding period approach assumes a stable dividend, whereas the dividend changes given the supernormal growth in this approach. The dividend discount model (DDM) is one of the most basic of the absolute valuation models. The dividend model calculates the "true" value of a firm based on the dividends the company pays its shareholders. The justification for using dividends to value a company is that dividends represent the actual cash flows going to the shareholder, thus valuing the present value of these cash flows should give you a value for how much the shares should be worth. So, the first thing you should check if you want to use this method is if the company actually pays a dividend. Secondly, it is not enough for the company to just a pay dividend; the dividend should also be stable and predictable. The companies that pay stable and predictable dividends are typically mature blue-chip companies in mature and well-developed industries. These types of companies are often best suited for this type of valuation method. This method has some weaknesses: - Dividends must be predictable and sustainable. If dividend growth or payout ratios change dramatically, the DDM model will not work. - How dividends are reinvested are very important to cumulative returns, but are ignored by the model. - Dividends are taxed based on the year they are incurred. Capital appreciation is not taxed until it is realized as a capital gain. 3. Results of valuating APC’s stock 3.1. Stock Valuation using RIM Step 1: Calculate Beta Creating daily price data of stock APC and Vn-index with 120 observationsfs, (source: www.vndirect.com.vn), we can calculate stock’s rate of interest and market’s rate of interes We can get Beta by using Regression in Excel or using formula: Beta = Covarian (Ri, Rm)/Var (Rm) CELEBRATE VIET NAM TEACHERS’ DAY 20/11/2018 54 Journal of Marine Science and Technology No. 56 – November 2018 Manner 1: Beta = Covarian (Ri, Rm)/Var (Rm) Covarian (Ri,Rm) Var (Rm) Beta 2.49509E-05 3.1361E-05 0.795605208 Manner 2 : Running Regression SUMMARY OUTPUT Regression Statistics Multiple R 0.1814751 R Square 0.032933212 Adjusted R Square 0.024667684 Standard Error 0.024452116 Observations 119 ANOVA df SS MS F Significance F Regression 1 0.0023823 0.0023823 3.984405073 0.048246 Residual 117 0.069954997 0.000597906 Total 118 0.072337297 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.003945419 0.002268177 1.739466999 0.084582534 -0.00055 0.008437 -0.00055 0.008437 X Variable 1() 0.802347625 0.401958141 1.996097461 0.048245827 0.006291 1.598405 0.006291 1.598405 Get the average:  = 0.798976417 CELEBRATE VIET NAM TEACHERS’ DAY 20/11/2018 Journal of Marine Science and Technology No. 56 – November 2018 55 Step 2: Calculate capital cost of APC According to CAPM: rt = rf +  (rMt – rf) Rf: risk free, normally based on long-term government bond (10 years). Until June 2017, this interest is 6% Monthly Average close price Month 2017 2016 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 1 683.26 548.30 571.33 531.22 454.49 356.82 494.64 501.76 308.50 841.89 927.96 308.23 2 708.25 551.67 579.37 571.13 482.61 408.51 497.08 495.46 266.91 753.06 1,083.76 344.35 3 715.91 572.67 577.80 591.05 480.09 441.15 466.06 513.30 261.54 583.80 1,110.99 440.18 4 718.74 578.07 556.60 582.69 490.24 461.04 462.27 521.25 320.20 531.89 1,002.78 564.54 5 731.00 611.50 552.20 541.79 495.14 455.77 447.99 515.05 389.33 469.73 1,046.35 559.99 6 759.73 625.41 581.59 567.35 503.98 426.98 439.15 507.66 470.46 382.68 1,044.65 526.59 7 772.77 657.16 624.80 590.88 491.57 415.00 417.70 501.31 439.77 449.54 987.53 480.40 8 776.58 653.39 580.27 611.36 494.78 414.54 398.29 458.67 505.51 491.48 905.38 457.85 9 801.98 668.27 565.33 621.20 478.38 393.93 447.91 454.47 559.63 485.25 954.71 513.50 10 820.43 682.03 589.45 601.72 498.09 392.32 414.13 453.32 591.51 383.33 1,090.92 526.52 11 892.69 673.29 602.33 593.09 502.59 382.21 393.62 441.19 535.58 341.37 1,004.32 572.29 12 950.73 663.24 569.67 548.11 506.94 394.00 368.50 474.35 475.69 303.38 943.30 729.20 Growth rate to previous period 2017/2016 2016/2015 2015/2014 2014/2013 2013/2012 2012/2011 2011/2010 2010/2009 2009/2008 2008/2007 2007/2006 2006/2005 1 0.24613 -0.04031 0.07552 0.16883 0.27371 -0.27863 -0.01418 0.62642 -0.63356 -0.09275 2.01063 2 0.28383 -0.04782 0.01443 0.18342 0.18140 -0.17819 0.00327 0.85631 -0.64557 -0.30514 2.14729 3 0.25011 -0.00887 -0.02243 0.23114 0.08827 -0.05345 -0.09204 0.96263 -0.55201 -0.47452 1.52395 4 0.24336 0.03856 -0.04476 0.18858 0.06333 -0.00267 -0.11315 0.62789 -0.39799 -0.46959 0.77629 5 0.19543 0.10738 0.01922 0.09422 0.08637 0.01736 -0.13020 0.32294 -0.17117 -0.55108 0.86851 6 0.21478 0.07535 0.02509 0.12574 0.18034 -0.02772 -0.13495 0.07906 0.22937 -0.63367 0.98381 7 0.17593 0.05178 0.05740 0.20203 0.18450 -0.00646 -0.16679 0.13995 -0.02173 -0.54479 1.05565 8 0.18854 0.12602 -0.05085 0.23561 0.19355 0.04082 -0.13166 -0.09265 0.02854 -0.45716 0.97749 9 0.20008 0.18209 -0.08994 0.29854 0.21437 -0.12051 -0.01442 -0.18791 0.15327 -0.49173 0.85921 10 0.20292 0.15707 -0.02040 0.20807 0.26959 -0.05267 -0.08643 -0.23363 0.54309 -0.64862 1.07196 11 0.32587 0.11781 0.01558 0.18006 0.31496 -0.02900 -0.10781 -0.17624 0.56893 -0.66010 0.75492 12 0.43345 0.16426 0.03932 0.08122 0.28664 0.06919 -0.22315 -0.00281 0.56798 -0.67839 0.29360 Rm 12,51% CELEBRATE VIET NAM TEACHERS’ DAY 20/11/2018 56 Journal of Marine Science and Technology No. 56 – November 2018 According to CAPM: rt = rf +  (rMt – rf) we have: r= 11.20% Step 3: Valuating APC based on RIM method To apply this model to the reality, we need assumptions relate to future cash flow and salvage value. In this paper, the author takes 2 years as growth periods, after 2 years, assumes cash flow is sustainable. Therefore, RIM can be described as: 2013 2014 2015 2016 Average EPS (VND) 1,360 2,168 2,293 3,503 DPS (VND) 1,000 500 500 500 POR = DPS/EPS 73.5% 23.1% 21.8% 14.3% 33.2% pb = 1 – POR 26.5% 76.9% 78.2% 85.7% 66.8% Po (VNĐ/shares) 18,450 ROE 10.01% 15.20% 15.09% 20.28% 15.1% Growth rate (g) = ROE tb * b tb 10.12% Units Year 2017 2018d (1) Growth rate (g) % 10.12% 10.12% (2) Capital cost (r ) % 11.20% 11.20% (3) Dividend payout ratio (d) % 33.2% 0.0% (4) EPS of previous year đ 3,503 3,858 (5) Expected EPS = (4)*[1+(1)] đ 3,858 4,205 (6) Book value in previous year đ 18,450 21,028 (7) Expected book value = (6)+(5)*[1-(3)] đ 21,028 25,233 (8) Expected surplus EPS = (5)-(2)*(6) đ 1,502 1,454 (9) Final value đ 12,978 (10) Discount rate 0.899 0.809 (11) Present value = [(8)+(9)]*(10) đ 1,351 11,671 (12) Price = Book value 2016 + present value đ 31,472 (Source: Financial reports in 2014, 2015, 2016 of APC) All in all, based on RIM method, the intrinsic price of APC is VND 31,472 much lower than market price VND 81.000 on Jan 10th 2018. Theorically, we should not by this stock; however, investors have a positive outlook on this stock. 3.2. DDM in valuating APC’s stock In this paper, the author assumes company experiences 2 supernormal growth. We take the calculate of g, r above. The time assumption is 5 years. Replace Do = 500đ, g = 10.12%, r = 11.12%, n = 5 into the formular: This price is lower than APC market price on Jan 10th 2018. The same to RIM, the intrinsic value of APC is much lower than current market price. Theorically, we should not by this stock; however, investors have a positive outlook on this stock. CELEBRATE VIET NAM TEACHERS’ DAY 20/11/2018 Journal of Marine Science and Technology No. 56 – November 2018 57 4. Summary Even the intrinsic value of APC is lower than market price while using RIM or DDM method, the values are different: P (RIM) = VND 31,472 P (DDM) = VND 6.731 P (RIM) is higher than P (DDM) because assumptions of DDM (growth rate and time assumption) are not as reasonable as RIM. For DDM, the dividends must be predictatble and sustainable. If dividend growth or payout ratios change dramatically, the DDM model will not work. DDM model is suitable for matured firms or blue-chip Company. It needs more variables than RIM models (growth rate 1, growth rate 2, n: the growth years) while RIM model only assumes one growth rate for calculation. Obviously, the more variables we apply, the more mistakes we may face with. As a result, using RIM to valuate APC’s price appears to be more rationable than using 2 period DDM. Nevertheless, the intrinsic value of APC estimated by DDM and RIM is much lower than the current market price. For some reasons, investors still have good expectation about APC. However, the author believes that this scenario just exists in short term, especially for surfing investment. In long term, the price of APC will drop down to its intrinsic value; therefore, if we want to invest in APC for long term, we should not buy this stock at this moment. REFERENCES [1] Subramanyam, K và Wild, J. Mc-GrawHill, New York., Finanancial Statement Analysis, 2009 [2] Brown, Christian; Abraham, Fred Journal of Economics, Sum of Perpetuities Method for Valuing Stock Prices, pp.59-72, 2012. [3] Demirakos, E. G., Strong, N. and Walker, M. Accounting Horizons 18, What valuation models do analysts use?. pp. 221-240, 2004. [4] Stephen Ross, Randolph Westerfield, and Jeffery Jaffe, Irwin Corporate Finance, pp. 115-130, 1990. Received: 11 January 2018 Revised: 08 March 2018 Accepted: 13 March 2018
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