Example Of Report On Equity Valuation: Phoenix Group Holdings

Ticker: PHNX Current Stock Price: £8.56/share

One year stock performance
Valuation Summary
Price Performance
Analyst Recommendation
Introduction
Founded in the year 1792, Phoenix Group Holdings is one of the largest insurance companies in the United Kingdom. The company provides services related to consolidation of closed life assurance fund, management of pension funds and closed life funds in the United Kingdom. The company is listed on London Stock Exchange under the ticker symbol of ‘’PHNX’’, and was previously known as Pearl Loan Company, with name changed to Phoenix group Holdings in March, 2010.

Price Performance Analysis

The table below compares the stock performance of the company with that of a chosen market index, i.e. FTSE-250 market index fromJan,2014-Dec, 2014, with return also calculated on risk-adjusted basis.
*In order to calculate the risk adjusted return, we have used the beta factor of 1.69 of the company and used the same in the following formula:
Risk-adjusted return= Monthly return- (Beta* Monthly Return on Market Index)

News Analysis

Stock Valuation
In this section, in order to calculate the intrinsic value of the stock we will be using the Multi-Stage Dividend Discount Model and Comparable Method.
-Multistage Dividend Discount Model
One of the most popular method of equity valuation that calculates the intrinsic value of the stock by discounting dividends while the dividend payments grow at different rates under different time periods.

Calculative Notes:

i) Required Rate of Return
Under this method, we assume the risk-free rate to be 3%, and the market risk premium to be 6%. Thus, with given beta of the stock at 1.69, we are able to calculate the required rate of return of the company using the CAPM Model:
= Risk-free rate+ Beta(market risk premium)
= 3+ 1.69(6)
= 13.14%
ii) Dividend Growth Rates
Here, we will be using two stage dividend growth model under which we will assume two growth rates, i.e. one for short-term and other for long-term.

Calculative notes for DDM:

Growth Rate (short-term)= Retention Rate* (Profit Margin* Asset Turnover* Financial Leverage)
= (1- DPS2013/EPS2013) * (Profit Margin* Asset Turnover* Financial Leverage)
= (1 -0.53/0.68) *(3.41*0.05*27.57)
= (0.22)* (4.70)
= 1.03%
Note: Growth Rate= Retention Rate(RR)* ROE
= RR*( Profit Margin* Asset Turnover* Financial Leverage)
Now, in order to calculate the terminal year growth rate, i.e. the long-term growth rate, we assume it to be 4.30%, based on economic model proposed by Bank of England.
Rationale for growth rate of 4.30%: The LT growth rate is based on an economic based model. It based Bank of England Monetary Policy Committee targets inflation rate at 2% being added to the UK long term growth potential that is estimated at 2.3% in a report by Oxford Economics, making a terminal growth rate at 4.3%.

Thus, using the above financial numbers, we calculated the intrinsic value of the stock to be:

Dividend for year 2014: 0.53(1.010)= £0.54
Dividend for year 2015: 0.54(1.010)= £0.545
Dividend for year 2016: 0.545(1.010)= £0.550
Terminal Value: 0.550(1.0430)= £0.57
V0= D20141+k + D20151+k2 + D2016(1+k)3 + D2016 ×(1+g) k-g× (1+k)3 = 0.541.13 + 0.5451.28+ 0.5501.45+ 0.570.08 ×1.45= £6.18
Thus, the final results of DDM valuation indicate that the intrinsic valuation of the stock is £6.18. Thus, compared to present value of the stock of £8.56, the stock is overvalued.

Valuation through comparable

This method calculates the value of the stock based on the average price multiple of the stock of similar companies or using the sector median for various fundamentals. The economic rationale for calculating the intrinsic valuation of the stock using the comparable is the Law of one price, i.e. two similar assets should sell at a comparable price multiples.

Now, we will calculate the intrinsic value of Phoenix Stock using various price multiples and sector median:

-Valuation using PE ratio:

EPS of the stock: £0.68

Sector Median PE: 14.1
Thus, fair value of the stock is: EPS x Sector median PE
= 0.68*14.1
= £9.58
-Valuation using Dividend Yield Percentage

Dividend per Share of Phoenix Holdings: £0.53

Sector median dividend yield: 2.86%
Fair Value: DPS/ Sector Median DY
= 0.53/0.0286
= £18.53
-Valuation using Price to Sales Ratio

Price to Sales ratio of Phoenix Holdings: £0.40

Sector median Price to Sales ratio: 2.90
The Sales per share of Melrose PLC and the Fair value can be calculated by:
SPS= Market Price/ Price-Sales Ratio
= 8.56/0.40
= £21.4
Fair value= SPS* Sector median Price-to-sales ratio
= 21.4*2.90
= £62.06
-Valuation using Price- Book Ratio

Price to Book ratio of Phoenix Holdings: £0.70

Sector median Price to Sales ratio: 1.1
The book value per share of Melrose PLC and the Fair value can be calculated by:
BPS= Market Price/ Price-Book Value Ratio
= 8.56/0.70
= 12.22
Fair value= BPS* Sector Median price- book ratio
= 12.22*1.1
= £13.45

Thus, on an average valuation under the 4 approaches of comparable method, we get the following intrinsic value of the stock:

= (9.58+18.53+62.06+13.45)/4
= £25.90
Hence, comparing the intrinsic value of the stock with the present value of £8.56, we believe that the stock is relatively undervalued.

Summary of Comparable Approach:

SML Analysis
For commenting over the SML analysis, we will be using the average intrinsic value generated under the comparable method, i.e. £25.90. Furthermore, using the CAPM calculations, we asserted the required rate of return on the stock to be 13.14%. Thus, in one year time, the price of the stock is expected to be:
= 25.90(1.1314)
= £29.30/share
Assuming that market price of the stock will attain its intrinsic value of £29.30, then the expected return based on current price will be:
E(r) = (29.30-8.56)/8.56
= 242.28%

Thus, we believe that there is a good and attractive investment opportunity hidden in the stock.

Analyst Recommendations
We also viewed recommendations of the analyst from multiple financial websites such as Yahoo Finance and Financial Times. Each of the website had a consensus recommendation that the stock is undervalued and is expected to provide appreciable returns to the investors. Referring to the analyst opinion provided on Yahoo Finance, during the current month, one group of analysts have rated the stock as ‘’Strong Buy’’, while three analyst group has rated the stock as ‘’Hold’’. Below is the summarized recommendation of the analysts for the stock since 3 months:
Similar trend in the analyst recommendation is witnessed in the analyst opinion posted on Financial Times. Below is the recommendation trend of the analyst on Financial times for the company’s stock for this month:

Comparing DDM and Comparable Method

As discussed briefly in the above section, DDM method is indisputably the most popular method equity valuation as it provides an easy and straightforward guide for applying the model. In addition, the model is assumed to provide accurate results because it discounts the cash flows of the company which are difficult to distort. However, on the other side, the model also suffers from several limitations as majority of its inputs are based on the assumptions of the user. For instance, an analyst has to very sure about the growth rates he is using in the model to project the dividend payments. Moreover, any marginal change in the growth rates can largely change the final outcome of the DDM model. For instance, in the above calculations, if we had used long-term growth rate from the Gordon growth model, and not the one proposed in the economic model, we must be having completely different results compared to what we calculated under our own assumptions.
Thus, even if one of the relevant assumptions is wrong, then we will be having incorrect intrinsic value of the stock, and this can bring carnage to the investor’s life if he followed our recommendation.
On the other side, the valuation based on market multiples is more rationale and produced results by applying various valuation techniques relating to PE, PS, Dividend Yield, etc. Moreover, the core advantage of this valuation model is that is quick and easy to understand, although analysts have to be cautious while selecting sector median multiples for each fundamental from a reliable source.
This equity valuation technique also suffers from the limitation that it fails to take into account future predictions and is less likely to be of value at predicting long term effects. Thus, while comparable method is more analyst friendly and simple, but unlike DDM method, it fails to take into account vital future predictions which are more suitable for an investor seeking recommendations from the analysts.

Conclusion: Buy

At the end of this report, we will give a buy recommendation to the Phoenix’s stock where our recommendation is well supported by the results of comparable method which indicated that the average intrinsic value of the stock is £25.90 as against the current share price of £8.56. In addition, we also discussed the analyst recommendation for the stock where the majority of the analyst groups are recommending the stock with strong potential to grow. Although, our DDM valuation indicated that the stock is overvalued but as we discussed in the subject body that this model works extensively on assumptions relating to growth rates. Hence, we conclude this report that the investors should buy this stock.

Works Cited

UK insurers want independent probe into news of sector review. (2014, April 8). Retrieved March 15, 2015, from Reuters: http://finance.yahoo.com/news/uk-insurers-want-independent-probe-092515398.html
Phoenix Group Holdings PT Raised to GBX 888 at Berenberg Bank (PHNX). (2015, January 7). Retrieved March 15, 2015, from http://www.i3investor.co.uk/servlets/fdnews/26279.jsp
Phoenix Group Holdings Receives GBX 571.82 Consensus Price Target from Brokerages (LON:PHNX). (2015, March 7). Retrieved March 15, 2015, from http://www.lulegacy.com/2015/03/07/phoenix-group-holdings-receives-gbx-571-82-consensus-price-target-from-brokerages-lonphnx/
Analyst Opinion: Phoenix Group Holdings. (n.d.). Retrieved March 15, 2015, from Financial Times: http://markets.ft.com/research/Markets/Tearsheets/Forecasts?s=PHNX:LSE
Bank of Engalnd. (n.d.). Monetary Policy Framework. Retrieved March 15, 2015, from Bank of England: http://www.bankofengland.co.uk/monetarypolicy/Pages/framework/framework.aspx
Charts: PHNX v/s FTSE Mid 250. (n.d.). Retrieved March 15, 2015, from Yahoo Finance: http://finance.yahoo.com/echarts?s=PHNX.L+Interactive#%7B%22scale%22%3A%22linear%22%2C%22comparisons%22%3A%7B%22%5EFTMC%22%3A%7B%22color%22%3A%22%23ff00ff%22%2C%22weight%22%3A1%7D%7D%7D
Historical Prices: FTSE Mid 250. (n.d.). Retrieved March 15, 2015, from Yahoo Finance: https://uk.finance.yahoo.com/q/hp?s=%5EFTMC&b=1&a=00&c=2014&e=3%60&d=11&f=2014&g=m
(2012). Market Based Valuation. In Kaplan, Equity Investments (pp. 185-210). USA: Kaplan.
Morningstar. (2015). Phoenix Group Holdings Quantitative Equity Report. Morningstar.
Multi Stage DDM. (n.d.). Retrieved March 15, 2015, from Investopedia: http://www.investopedia.com/terms/m/multistageddm.asp
Phoenix Group Holdings (PHNX:London). (n.d.). Retrieved March 15, 2015, from Bloomberg: http://www.bloomberg.com/research/stocks/snapshot/snapshot.asp?ticker=PHNX:LN
Phoenix Sees Earlier Investment Grade Rank in Deals Push. (n.d.). Retrieved March 15, 2015, from Bloomberg News: http://www.bloomberg.com/news/articles/2014-08-21/phoenix-profit-rises-as-company-restructures-bank-debt?cmpid=yhoo