Stock Investment in the UK Market Based on Fundamental and Industry Analysis - Case Study Example

Rationale for choosing the two companies and industries based on your industry and fundamental analysis Table of Contents Introduction 3 Industry and Fundamental Analysis 3 Economic Analysis 3 Industry Analysis 4 Telecommunication 4 Pharmaceutical 5 Company Analysis 7 Vodafone Plc 7 Astrazeneca PLC 8 Share Valuation 10 Zero Growth Dividend Model 10 Constant Growth Dividend Model 12 P/E Approach 14 Investment Advice 15 Conclusion 16 Introduction This paper will attempt to offer investment recommendation for stock investment in UK market based on fundamental and industry analysis and share valuation using the financial techniques such as zero growth dividend model, constant growth dividend model and P/E approach. Industry and Fundamental Analysis Economic Analysis After the financial crisis of 2008, with recovering economy, the stock market is expected to grow in coming years with recovering economy (Neate, 2011). Moreover, some experts believe that UK stock market is still undervalued (Boyce, 2011). During last financial year i.e. in 2010, companies have experienced higher growth and hence, there had been higher dividend yield (Vellacott and Cruise, 2011). UK economy has been experiencing slower economic growth but it steady and expected to grow much higher by 2012. However, due to sluggish economic recovery, Confederation of British Industry (CBI) has claimed that “expected national output to increase by 1.3% in 2011 compared to the 1.7% it had been predicting three months ago” (Elliott, 2011). During 2007-2009, overall GDP growth was negative due to global crisis, but during 2010, these parameters have taken an increasing trend that will make stock market grow in coming years. Industry Analysis Telecommunication UK telecommunication industry is highly developed in terms of industry polices and market exposures like demand. For example, during end 2010, nearly 4.8 million and 33.1 million were the users of mobile broadband and 3G mobile (Ofcom, 2011). Figure 6 portray that mobile ownership has been grown from 50% to 91% since last 10 years and figure 7 shows that there also have been growth in broadband connection. The market report also signifies that there has been a slight decline in annual revenue of telecommunication industry as presented in the following figure. However, it is expected that, during 2011, industry revenue is expected to grow by 2% to £35.6 billion and annual growth rate will grow rate nearly 3%-4% p.a. By the end of 2015, market is projected at £40.7 billion i.e. “equivalent to cumulative growth of 17% in real terms compared with 2010” (MBD, 2011). Pharmaceutical Multiple new product development led by technological advancement and government’s initiatives are expected to bring rapid growth in healthcare industry. Comparing to other manufacturing industries, pharmaceutical has shown a better performance. The above figures show UK’s Pharmaceutical trade, there has been significant growth in this industry since last decades. The overall import and export has increased and medical pharmacy products are the highest gainer. Company Analysis Vodafone Plc Vodafone Group is one of leading global telecommunication company, and in UK Vodafone’s performance has been remained better than its rivals. A key comparison of Vodafone with its key rivals British Telecom and Telefonica SA are given below. The overall performance of Vodafone has been better than its rivals in terms of profit margin and its sales and stock returns its performance has remained quite better. Moreover, with lowest debt-equity ratio, it also has lower risk level. The following table depicts the financial highlights. Vodafone’s net profit margin and sales volume are very high that clearly signifies its better financial performance. Its shareholders have also gained a higher return on their investments as earning per share and dividend payout ratio are attractive for making investments. The key ratios of Vodafone indicate that financial condition is very stable than its key rivals. Return on equity is also quite higher i.e. 8.69%. Therefore, it is expected that with stable financial condition it will keep performing better in terms of financial performances. Astrazeneca PLC Astrazeneca PLC is the third largest pharmaceutical company in UK in terms of size and market share. The following table shows market shares of leading companies. A company with higher market have greater chance to generate higher sales revenue which is very necessary to better financial performance. Astrazeneca’s market share is 7.2% which quite higher comparing to other market leaders. The following table shows a comparison of Astrazeneca PLC with its key rivals. Astrazeneca is smaller in size comparing to GlaxoSmithKline Plc but its other key performance indicators are showing a strong growth. Total income of Astrazeneca is 4.99% which is the best comparing to its three competitors and indicating better operational performance that has led to make its financial considering stronger. Besides, its profit margin, price-earnings, sales growth etc are very impressive signifying better financial performances and better for stock investments. The following table depicts the financial highlights of Astrazeneca in order to assess management’s performance. As per above table, investors must focus on its net profit margin, return on equity and payout ratio. These three factors are vital for stock performance and as the company has shown a better performance its stock may offer a higher return in future. Share Valuation Zero Growth Dividend Model Dividend Discount Model considers that value of a share is mainly based on present value of the future dividend. In this regard there are two theories i.e. zero growth model and constant growth model. In case of zero growth model, it is assumed that dividends will remain same in the future i.e. there will no growth in dividend paying. The major two components of this model are dividend and required rate of return. The share valuation method is given below. Here, R is the major factors as in include a number of components. To determine the required rate of return can be calculated using CAPM model has been used as given below. Return on one year UK government bond has taken as risk free rate of return i.e. 5% p.a. (Bloomberg, 2011). The beta of Astrazeneca and Vodafone are .61 and .66 respectively (Leonard N. Stern School of Business, 2011). The beta of a stock signifies its volatility in respect of market performance. To calculate the intrinsic value as per zero growth model, the above given data i.e. risk free rate of return, β of stock, and expected return on market are used to calculated required rate of return for Vodafone and Astrazeneca which are 5.132% and 5.132% respectively. Using the required rate of returns, the latest dividend has been discounted to obtained intrinsic value of stock. The intrinsic value of stocks for Astrazeneca and Vodafone are 3145.25 pence and 173.42 pence respectively. Constant Growth Dividend Model The primary concept of zero growth model and constant growth model is same, but the later assumes a constant growth of dividend in future that are converted into present value as per time value of money concept. The necessary inputs in this method are required rate of return, growth rate of dividend and the latest dividend paid. Under this method stocks’ intrinsic values are calculated as follows. The required rate of return is already calculated in previous section. The growth rate is obtained by multiplying dividend retention rate with return on equity. The future dividends of each year can be calculated with the same concept of time value of money. The following table depicts intrinsic value of share as per constant growth rate model. In constant growth model, a primary assumption and the most vital assumption is that required rate of return must be higher that growth rate. The growth rate is calculated by multiplying dividend retention rate and return on equity. All these date are presented in the above table. Using all the components like beta, growth rate, dividend, the intrinsic value has been calculated. The required rate of return has been adjusted with growth rate and finally it has been used to discount expected dividend. However, in case of Astrazeneca, growth is higher than required rate of return and hence, share price remains negative i.e. -1209.19 pence. On the other hand, in case of Vodafone, this model works and intrinsic value of stock is nearly 683.16 pence. P/E Approach Price-Earning approach is based on multipliers and it considers the estimated earnings per share and estimated P/E ratio, and intrinsic value of share can be calculated by multiplying each other. The following table shows P/E and EPS of both companies for last five years. The estimated EPS is calculated based on compounded growth rate of last five years, and estimated P/E is calculated as per average of last five years performance. The following tables shows value of share based on P/E approach. Above table represents the calculation of intrinsic price of the share for Astrazeneca and Vodafone. As it has been already discussed that P/E approach uses estimated EPS and estimated P/E for determining intrinsic value of stock, these two components are calculated based on the historical performance of EPS and P/E (refer to table 8). In order to find estimated EPS, the growth rate of last five years EPS has been adjusted with the EPS of last financial year. The estimated P/E has been calculated based on last five years’ average. Finally, to obtain intrinsic value of stock, estimated EPS and estimated P/E has been multiplied, and the intrinsic value of Astrazeneca and Vodafone are 3186.072 pence and 171.55 pence respectively. Investment Advice The zero growth dividend discount, constant growth dividend discount model and P/E approach suggests that Astrazeneca’s stock must be bought; whereas, Vodafone’s stock must be sold, as it is traded being overvalued. The overall analysis focused that Astrazeneca’s stock has better growth in future than Vodafone. Another consideration for making investments in stock market is to assess economic parameters like inflation and interest risk as these two factors influence industry’s and companies’ performance which influence stock performance. Higher inflation rate leads to increase the price of products and it increases cost of production of company and finally, financial performances affected. On the other hand, higher interest risk leads to increase the required rate of return and raises intrinsic value of stock. However due to higher interest rate, demand of stock also reduces that causing lower price of stock. Conclusion This paper has attempted to present stock analysis recommendation for buying, selling and holding. The investment recommendations are based of analysis of two different industries and one company from each industry. The two selected industries are telecommunication and pharmaceutical and their respective companies are Vodafone Plc and Astrazeneca Plc. Industry analysis indicates that telecommunication is one of the fastest recovering industries; whereas, pharmaceutical has a constant growth with defensive nature. Reference ABPI-a. (2011). Pharmaceutical trade in the UK. [Online]. 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