Fair Value of Amazon’s Stock

Fair Value of Amazon’s Stock

The estimation of the fair value of a stock is both an art and a science that offers a picture of the future and the actual worth of a company. The act of getting to know about the entity and business dynamics (product and competition, etc) constitutes the art, while the act of relating the knowledge with economic performance constitutes the science. According to (Asquith and Mickail 254), the stock’s fair value signifies its worth and has a close correlation with how much cash flows can be realized in the future, say 10 years ahead. In business, cash represents the inflows and outflows that managers can save or pay for expenses incurred. Free cash flows, on the other hand, are monies used to incur debt, pay dividends, and accrue back to business.

In auctions, we always witness bidding taking place. At a certain price guide, a product on auction can fetch higher prices in a few minutes. The determination to buy a good at a high price or lower price heavily relies on evaluated worth based on several prevailing factors. Stocks operate in a similar way. Publicly traded stock averages millions and the stock price varies depending on the current trading whims as well as popularity. Investors have no option other than to evaluate the fair value of trading stocks prior to bidding. Usually, the share price portrays the fairness of any company listed on the stock exchange.

(Stephen 43 ) points out that information is key in the estimation of the FVE. Without relevant information like current stock price, discount rate, annual dividends, sales, and earnings per share (EPS), it would be hard to perform a valuation. Various models are used to calculate the FVE. One of the models used was Discount Cash Flow (present valuation of all future prices/cash flows less discount rate). The generation of future cash flows relies on the current prevailing rate.  With this in mind, the effective interest rate was calculated using the asset pricing model.

Growth rate

(Journal of Financial Economics 347) points out that the future of any business is certainly unknown, but predictions can be computed. Analysts can make use of factors like competition, leadership, technology, commodity quality, economic shifts, and other industry changes to predict the future. Relying on previous revenue figures for a few past financial years was not sufficient due to the lack of information on the underlying drivers. However, assumptions are not any better when component sections are amiss. Bloomberg.com highlights that Amazon is a steady company with a projected annual growth rate of 1.5%. It involved estimation  of shifts in market share over 10 years with an annual increment of 1.5%.

The formula applied: [((current- previous)/ previous)*100 to get a percentage value.

Profit margins emphasized on evaluating future revenue margins. As such, Earnings Before Interest and Tax ( EBIT) ranges were required. It was not worth extrapolating (predicting the future using past data). The factor, competition, played a role in evaluating revenue margins likely to be generated in subsequent years by discounting them. In this case, the time value of money came into play with considerations of the present state. This was essential as the worth of a dollar is destined to rise in future compared to the prevailing value.

To evaluate the discount rate/ cost of equity

The computation was made easier using the Capital Asset Pricing Model (CAPM). The following formula was used:

ERi = Rf + Beta(ERm – Rf) (Asquith& Mikhail 84).

Whereby:

The ERi was the discount rate; the Rf was the time value of money (Risk-free rate), Beta was the investment risk which according to Gurufocus (Gurufocus.com), Amazon pages (Amazon.com) was 1.60  and the value (ERm – Rf) was 6 % (Gurufocus.com).

This approach takes the equity and debt costs into consideration. The cost of debt amounts to the interest rate applied to borrowed debt subject to the current bond’s price. This is about attaching rates to the nature of the risk involved. On the other hand, equity cost was a percentage based on the borrower’s classification in terms of risk. Zero debt equals zero cost of debt. The cost of equity was represented by the calculated discount equal to 11.43%

The annual internal rate of return/ discount factor can be computed by forecasted free cash flows in a particular year over the internal rate of return.

The current share price needs to be near equal to the terminal value at the present value. Since most companies have perpetuity above 10 years, a capped limit of 10 years was set such that all cash earned ought to be accounted for completely as a lumpsum number.

Intrinsic value = (cash flow in the 10th year (1 + LTGR))/(WACC*(1 – LT growth rate))

The current value of terminal value needs implies discounting end tail TV to present. The ultimate valuation involved summing up cash flows over the 10 years, then discounting it to present value, subtracting applicable borrowed money and applicable adjustments, then dividing by a number of shares presently. Since debt is not the obligation of equity shareholders, the debt is subtracted, and any cash generated. The resultant equity amount is divided by the number of shares to arrive at Fair value of the Stock

The data was derived from both Bloomberg.com, economic trends.net, and Amazon.com. Despite the different sources of data, there was a correlation in the data as they all had consensus estimates.  From analysis the data constituted non-continuous data as they replicated qualitative financial information like revenue, BBIT, cost of equity, debt and capital approximation.

In conclusion, Amazon.com indicated that it is a steady company as the financial statements signified a company on an exponential phase. The growth rate is estimated to grow slowly at about 5.67%.

Works Cited

Peter Asquith, Rose Mikhail.  Information content of equity analysts reports. Journal of Financial Economics. 2005, 75, 245–282.10.1016/j.jfineco.2004.01.002

Stephen Valdez.  An Introduction To Global Financial Markets, Macmillan Press Ltd. 2001

https://www.bloomberg.com/quote/AMZN:US. Retrieved 03 December 2019

https://www.gurufocus.com/term/lynchvalue/AMZN/Peter%252BLynch%252BFair%252BValue/Amazon.com%2BInc. Retrieved December 2, 2019.

US Treasury Yields (this site provides a graph of the current Yield Curve) – http://www.bloomberg.com/markets/rates/index.html

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Description: Each student must complete an investment valuation of a publicly traded stock. This analysis is the same as the company valuation analysis discussed in class and on the mid-term exam. This time, the analysis will be conducted in real-time with real companies.

Fair Value of Amazon’s Stock

Parameters:

Select one company from the S&P 100, the top 100 companies in the S&P 500. There should be plenty of data on these companies with multiple analysts’ projections. I would suggest using the Bloomberg Terminal to get all of your data. USE the FA <GO> (financial analysis) function to see a company’s past and forecasted financial data. If you don’t use Bloomberg, you may have to use an internet resource. Whatever you use, please source the data.

Assignment: Complete your company valuation analysis on an Excel Spreadsheet and write a 3 to 5-page narrative on your analysis. Put both in the class Dropbox.

Requirements

1. Select a company from the S&P 100 (Company list on page 2)
2. Compute the fair value of your stock. You may want to solve for the current price first and then adjust your inputs so that you are not ‘way off’ from the market. These companies should trade around their fair value since these are the most widely followed companies on Wall Street. Some of the inputs you need are:
   1. Forward 1-year EPS
   2. Stock Beta
   3. Risk-free rate (use Ten-year Treasury bond)
   4. Short-term and long-term growth rates. (This will be the likely place in which you will fine-tune your model to get to the current market price)
3. Compute a discount rate using the Capital Asset Pricing Model. You will discount your cashflows using this
4. The biggest variability will come from the projected long-term growth rate and the required rate of return, so make sure to back up your assumptions for
5. The paper should address how you found your data and the type of data. Is the data a consensus estimate (all analysts), or is it from a third-party website (CBS Marketwatch, Yahoo Finance, ETC.)? But make sure it’s forward EPS and not trailing EPS. I would suggest using Bloomberg if you
6. Your paper should also discuss your future growth rate assumptions. This factor will have the most variation, so make sure to document your growth thesis. Also, tell me what stage the company is currently experiencing. Hypergrowth, growth, maturity,
7. You may also comment on the company’s sector. Use the S&P website to look at the future EPS for the entire sector. This will give you a start on the company’s assumptions by looking at the sector. This is especially true if you are selecting a large company within the sector.