Stock Valuation Term Paper

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[. . .] 14 + 0.074 = $4.214. The next step in this methodology is to plug this into the average price/earnings ratio. Morningstar gives us the average P/E for each of the past ten years, but perhaps given current economic conditions only the past five years is applicable. The average P/E over the past five years is 16.78 (the five years are 20.1, 17.2, 16.5, 15.5, 14.6). Using this average P/E we get: 16.78 * 4.214 = $70.71. This slightly undervalues the company compared with the current stock price. However, the P/E has an upward trend given the improvements in the economy, however subtle they might be. If last year's average P/E is used (20.1), then the P/E ratio method would deliver a stock price estimate of 20.1* 4.214 = $84.70, which is very close to the current share price. This methodology appears to be more in line with what the market is using.

P/CF Ratio

The next methodology is the price/cash flow ratio. The current P/CF ratio from Morningstar is 14.7, a figure that is higher than the 10-year average but more in line with non-recession values from the mid-2000s. The next step in this methodology is to estimate next year's cash flow from operations. Last year's was $612 million, but this figure has been declining steadily. The slope of the cash flow from operations line is -49.9, implying that next year's cash flow from operations will be around $562.1 million. On a per share basis, this would be 562.1 / 131.66 = 4.269, so the P/CF for next year should be 4.269 * 14.7 = $62.75, a figure significantly lower than the current share price for Clorox.

P/S Ratio

The price per sales ratio last year from Morningstar is 2.0. This again compares more with current economic conditions than the other figures of the last five years, which were affected by the recession. The sales last year were $5.468 billion. These have remained steady over the past four years, so the slope is only 0.0051. Thus, the expected sales for next year are $5.473 billion. That equates to $41.56 per share. If we apply the P/S ratio to that we get 2.0 * 41.56 = $83.14 as the stock price of the Clorox company.


The five different methods give us a variety of results. Two results are close to the current stock price -- the P/S ratio ($83.14) and the P/E ratio ($84.70). The P/CF ratio ($62.75) is out of line with market expectations, and shows the company as being presently overvalued. This is perhaps a bit deceptive. The slope of the operating cash flow line is negative because of a past history over the last four years of declining cash flow from operations. However, the market is also taking into account that the company has reported three quarters from its latest fiscal year, the 2013-year. In those three quarters, Clorox has recorded a combined total of $1.018 billion in cash flow from operations. This is significantly higher than previous years and is already double the expectation based on the slope of the cash flow line. Thus, the market is pricing in the expected cash flow that includes the first three quarters of known flows -- these are different from the expected flows based on the previous four years' worth of data. The idea that Clorox is overvalued holds little water when the reality of significantly improved cash flow from operations is taken into account.

The other two methodologies used are problematic for Clorox because of the negative value of the company's equity. This utterly undermines the residual income model by negating the equity charge. Clearly the company should have a cost of equity, but a WACC calculation will not show this because there is no equity book value. At this point, investors need to see that the balance sheet will have some equity on it in the future, and it is this future expectation from which the stock price derives, rather than from the present-day balanced sheet. Indeed, there is a small amount of equity on the balance sheet on the third-quarter balance sheet from the latest fiscal year, hinting that the expectation of future equity book value is reasonable on the part of investors.

Similarly, it is difficult to make sense of the dividend discount model because of the rock bottom cost of capital that the company has. The low beta in particular seems out of line with the fairly steady and strong dividend growth. The company has no equity value but it does deliver strong dividends to shareholders. This situation, however, is atypical for no-growth companies and makes it difficult to get good use out of the dividend discount model. The most reasonable conclusion is that in lieu of being able to use more common methods of valuation like the dividend discount model, the market is using the three price-based models to extrapolate the value of the company's stock. The result is that the figures from those models are quite close to the actual stock value. Given that there are little in the way of major changes to Clorox's business in the coming years, these valuations appear fair. Over time, other methodologies will put these valuations to the test but for now it appears… [END OF PREVIEW]

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Stock Valuation.  (2013, July 27).  Retrieved February 23, 2019, from

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"Stock Valuation."  27 July 2013.  Web.  23 February 2019. <>.

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"Stock Valuation."  July 27, 2013.  Accessed February 23, 2019.