GE stock analysis

| June 1, 2016

Question
Data Case

As a new analyst for a large brokerage firm, you are anxious to demonstrate the skills you

learned in your MBA program and prove that you are worth your attractive salary. Your first

assignment is to analyze the stock of the General Electric Corporation. Your boss recommends

determining prices based on both the dividend-discount model and discounted free cash flow

valuation methods. GE uses a cost of equity of 10.5% and an after-tax weighted average cost

of capital of 7.5%. The expected return on new investments is 12%. However, you are a little

concerned because your finance professor has told you that these two methods can result in

widely differing estimates when applied to real data. You are really hoping that the two

methods will reach similar prices. Good luck with that!

1. Go to Yahoo! Finance (http://finance.yahoo.com) and enter the symbol for General

Electric (GE). From the main page for GE, gather the following information and enter it

onto a spreadsheet:

a. The current stock price (last trade) at the top of the page.

b. The current dividend amount, which is in the bottom-right cell in the same box as

the stock price.

2. Next, click “Key Statistics” from the left side of the page. From the Key Statistics page,

gather the following information and enter it on the same spreadsheet:

a. The number of shares of stock outstanding.

b. The Payout ratio.

3. Next, click “Analyst Estimates” from the left side of the page. From the Analyst

Estimates page, find the expected growth rate for the next five years and enter it onto

your spreadsheet. It will be near the very bottom of the page.

4. Next, click “Income Statement” near the bottom of the menu on the left. Place the

cursor in the middle of the income statements and right-click. Select “Export to

Microsoft Excel.” Copy and paste the entire three years of income statements into a new

worksheet in your existing Excel file.Repeat this process for both the balance sheet and

cash flow statement for General Electric. Keep all the different statements in the same

Excel worksheet.

5. To determine the stock value based on the dividend-discount model:

a. Create a timeline in Excel for five years.

b. Use the dividend obtained from Yahoo! Finance as the current dividend to forecast

the next five annual dividends based on the five-year growth rate.

c. Determine the long-term growth rate based on GE’s payout ratio (which is one

minus the retention ratio) using Eq. 9.12.

d. Use the long-term growth rate to determine the stock price for year five using Eq.

9.13.

e. Determine the current stock price using Eq. 9.14.

6. To determine the stock value based on the discounted free cash flow method:

a. Forecast the free cash flows using the historic data from the financial statements

downloaded from Yahoo! to compute the three-year average of the following

ratios:

i. EBIT/Sales

Chapter 9: Valuing Stocks Page 1 of 2

http://wpscms.pearsoncmg.com/bp_berk_cf_2_global/141/36158/9256670.cw/content… 03/11/2011ii. Tax Rate (Income Tax Expense/Income Before Tax)

iii. Property Plant and Equipment/Sales

iv. Depreciation/Property Plant and Equipment

v. Net Working Capital/Sales

b. Create a timeline for the next seven years.

c. Forecast future sales based on the most recent year’s total revenue growing at

the five-year growth rate from Yahoo! for the first five years and the long-term

growth rate for years 6 and 7.

d. Use the average ratios computed in part (a) to forecast EBIT, property, plant and

equipment, depreciation, and net working capital for the next seven years.

e. Forecast the free cash flow for the next seven years using Eq. 9.18.

f. Determine the horizon enterprise value for year 5 using Eq. 9.24.

g. Determine the enterprise value of the firm as the present value of the free cash

flows.

h. Determine the stock price using Eq. 9.22.

7. Compare the stock prices from the two methods to the actual stock price. What

recommendations can you make as to whether clients should buy or sell GE stock based

on your price estimates?

8. Explain to your boss why the estimates from the two valuation methods differ.

Specifically, address the assumptions implicit in the models themselves as well as those

you made in preparing your analysis. Why do these estimates differ from the actual

stock price of GE?

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