Justified P/S Based on Forecasted Fundamentals.
As an automobile analyst, you are valuing the stocks of three automobile manufacturers including General Motors (NYSE: GM) as of the end of 2001. You estimate that GM’s required rate of return is 11 percent based on an average of a capital asset pricing model (CAPM) estimate and a bond yield plus risk premium estimate. Your other forecasts are as follows:
long term profit margin = 3.5 percent,
dividend payout ratio = 30 percent, and
earnings growth rate = 5 percent.
Although you forecast that GM’s profit margin for 2001 will be 1 percent, you recognize that 2001 was a year of economic contraction. A profit margin of 3.5 percent is close to GM’s long term average, and an earnings growth rate of 5 percent is close to the median analyst forecast, according to First CallI Thomson Financial. As a first estimate of GM’s justified PIS based on forecasted fundamentals, you decide to use Equation 4 4.
1. Based on the above data, calculate GM’s justified PIS.
2. Given an estimate of GM’s sales per share for 2001 of $295, what is the intrinsic value of GM stock?
3. Given a market price for GM of $53 as of 6 December 2001, and your answer to Problem 2, state whether GM stock appears to be fairly valued, overvalued, or undervalued.