Paragraph on Thomson Financial
NAV views a company’s worth as the sum of its net asset value. Major limitation of this method is its use of values stated in a company’s financials which are historical and fail to reflect true market value of those assets. NAV also does not take the cash earnings of the company into consideration. In view of this, current value methods are preferred. However Atrill (2005) identified a flaw of current value as they fail to take the company value as a going concern into account. NAV is useful because of its simplicity and ease of obtaining data in the valuation of a company.
It provides a minimum value comparable with the market value to make investment decisions and measure risk associated with investing in a company (Atrill, 2005). Various price multiples are used in the valuation of a company. For the purpose of this work I will be using the price to earnings ratio (PER). PER measures the markets confidence in a company (Pike & Neale, 2009). Damodaran (2006) also mentioned that one of the most intuitive ways of valuing an asset is a multiple of the earnings it generates and PER does this effectively.
In valuing GIS’s equity, values obtained are compared with CAG (a comparable firm). Comparable firms are those with similar growth potential, risks and cash flow (Damodaran, 2006). Principle underlying the use of comparable company as described by Hume (2000) is the law of one price which states that comparable assets ought to have the same price. The 2009 PER was calculated using EPS* for Q3 2009. A value of 2684 cents was obtained when the PER of CAG was used. This is about 53% of GIS market value ($50. 69).
This variance was less in previous years compared as shown in table 4 particularly in 2005 where the variance was less than 1%. DCF valuates a company based on the future cash flow adjusted for the time value of money. The method is now gaining popularity thanks to the criticisms and limitations of the use of accounting methods in equity valuation. DCF functions majorly on two elements: future cash flow and cost of equity. There are two models of DCF – Free cash flow to equity (FCFE) and free cash flow to firm.
The DCF model used here is the Free Cash flow to firm (FCFF) model. In estimating future cash flows, the 2009 account which provides the most recent financial data is used to ensure a more reliable estimate of future figures. Table 5 provides details of the 2009 base year figures. GIS’s revenue has been growing since 2005. This growth peaked in 2008 with a 9. 7% spike in revenue growth.
However, based on estimated figures for 2009 end of year (using 9 month financial report) this growth dipped to 1.1% and its attributable to the current financial and economic climate leading to reduction in consumer products. CAG’s revenue growth seems to be erratic with declines in 2005, 2006 and 2008. The major loss of revenue was in 2005, about 20%. See table 6. GIS’s main growth strategies include cost-saving efforts and price. They also increased our spending on advertising and other consumer marketing programs, which help generate consumer awareness and purchase their brands. Increased foray into international operations and partnership with retailers were some of the other strategies employed.
Although the prognosis for food manufacturing companies is stable, this especially applies to manufacturers of packaged foods such as GIS because of consumer’s propensity for “in-home” eating (Fitch 2008). Also GIS current drive towards international expansion in fast growth markets coupled with a historic review of their performance is my justification for a conservative estimated growth rate of 1% and 3% in 2010 and 2012 respectively. Sustainable growth rate will not exceed 3%.