Easy DDM question Part 2 - will it crush you?

CFA Level II Equities
#1

Company X has a trailing PE of 14. The dividend will grow at 4.5% into the indefinite future. Company’s X current divident is $0.7 and EPS is $2.0. The investor requires 8%. Is the company over, under fairly valued?

#2

dont paste pg no man just put q

#3

I got the correct under, fairly, overvalued part but my numbers were not what the answer showed, nor the way i calculated this.

#4

The company is overvalued. Justified trailing PE = 10.45 while market trailing PE = 14. In other words, the company should be trading at a lower PE that what the market is seeing.

Justified Trailing PE = ((1 - b)(1 + g))/(r-g)

((.35)(1.045))/(.08-.045) = 10.45

Hope that helps.

#5

Isnt it overvalued and the price shud be 20.9 instead of 28

#6

justified trailing P/E = 10.45 so stock is overvalued.

#7

overvalued

#8

NOTE: I didn’t know to use the trailing P/E formula. How would you know in the exam?

I calculated the value of the company:

PE X EPS = 28

D(1) = .7 / 1.08

Perpetuity calculation:

(.7 * 1.045) / (.08-.045) = 20.9

Current dividend + Perpetuity discounted back to T =0

( 20.9 + .7) / 1.08 = _ 20 _

Stock is overvalued!

#9

Without knowing the justified trailing PE formula, I think the stock’s value should be 20.9. I think you are doing an extra step at the end.

V at t = 0: div1/(r-g)

#10

Yea, i wudnt add current year dividend

#11

yep, overvalued. trick is its “trailing” so grow the payout ratio by 1+g.

@Rasec…you just need to recognize that you can use the trailing P/E formula. no trick here. You can do it your way also I guess, but thats confusing to me!

#12

why would you add the dividedn?

#13

How did you know to compute the trailing PE versus valuing the stock?

#14

How did you know to compute the trailing PE versus valuing the stock?

#15

I got overvalued: justified trailing P/E = 10.45

*justified trailing = [(1-b)(1+g)] / (r-g)

justified forward = (1-b) / (r-g)

*Edit It actually works out the same way. You are just comparing stock prices vs. P/E ratios. If you multiply the justified trailing P/E by EPS of 2 you get the stock price of 20.9

#16

Here was my thought process:

  1. They gave me a trailing P/E of 14. — okay, I’m in P/E land…

  2. they are giving me div, eps, growth. —okay i know the P/E formula uses all of those. Lets calculate the trailing P/E with whats given and see where it comes out. Turns out that the P/E I calculate is much lower, which implies the P/E of 14 is overvalued.