Valuing the Equity of a Stable-Growth Firm The Emerson Electric Company (EMR) wa
ID: 2741757 • Letter: V
Question
Valuing the Equity of a Stable-Growth Firm
The Emerson Electric Company (EMR) was founded in 1890 and is located in St. Louis Missouri. The firm provides product technologies and engineering service for industrial, commercial, and consumer markets worldwide. The firm operates in five business segments: process management, industrial automation, network power, climate technologies, and appliance and tools.
The company has a lengthy history of dividend payments and steady growth. In recent years, the firm’s dividend payout has averaged 40% of earnings. For 2007, firm earnings were estimated to be $5.69 a share, and on December 7, 2006, Emerson’s shares were trading for $86.01, which represents a price-earnings ratio of 19.276. Data for the industry, sector, Emerson, and four competitor firms are shown on the chart found after the problems.
1. Is Emerson’s current stock price reasonable in light of its sector, industry, and comparison firms?
2. Emerson’s beta coefficient is 1.27. Assuming a risk-free rate of 5.02% and a market risk premium of 5%, what is your estimate of the required rate of return for Emerson’s stock using the CAPM? What rate of growth in earnings is consistent with Emerson’s policy of paying out 40% of earnings in dividends and the firm’s historical return on equity? Using your estimated growth rate, what is the value of Emerson’s shares using the Gordon growth model? Analyze the reasonableness of your estimated value per share using the Gordon model.
Comparable Firms
Description
Market
Cap
P/E
Return on
Equity %
Dividend
Yield %
Long-Term
Debt to Equity
Price to
Book Value
Net Profit
Margin
Price to Free
Cash Flow
Sector: Industrial goods
16.606
14.94%
1.48%
0.87
50.471
5.40%
75.481
Industry: Industrial
equipment & components
15.900
18.40%
1.41%
0.649
10.11
7.90%
134.9
Emerson Electric Co
$34.61B
19.276
23.72%
2.40%
.0494
4.257
9.54%
65.156
Parker-Hannifin Corp.
$9.81B
14.150
18.16%
1.20%
0.308
2.298
8.25%
34.392
Roper Industries Inc.
$4.44B
24.685
14.27%
0.50%
0.603
3.122
11.89%
232.735
Pentair Inc.
$3.23B
17.943
11.56%
1.70%
0.485
1.974
4.48%
147.667
Walter Industries Inc.
$2.19B
23.537
15.70%
0.30%
4.036
2.731
7.38%
Comparable Firms
Description
Market
Cap
P/E
Return on
Equity %
Dividend
Yield %
Long-Term
Debt to Equity
Price to
Book Value
Net Profit
Margin
Price to Free
Cash Flow
Sector: Industrial goods
16.606
14.94%
1.48%
0.87
50.471
5.40%
75.481
Industry: Industrial
equipment & components
15.900
18.40%
1.41%
0.649
10.11
7.90%
134.9
Emerson Electric Co
$34.61B
19.276
23.72%
2.40%
.0494
4.257
9.54%
65.156
Parker-Hannifin Corp.
$9.81B
14.150
18.16%
1.20%
0.308
2.298
8.25%
34.392
Roper Industries Inc.
$4.44B
24.685
14.27%
0.50%
0.603
3.122
11.89%
232.735
Pentair Inc.
$3.23B
17.943
11.56%
1.70%
0.485
1.974
4.48%
147.667
Walter Industries Inc.
$2.19B
23.537
15.70%
0.30%
4.036
2.731
7.38%
Explanation / Answer
1. Is Emerson’s current stock price reasonable in light of its sector, industry, and comparison firms?
· The current stock price is reasonable when compared to sector, industry and other firms except Roper Industries Inc.
2. (a) Emerson’s beta coefficient is 1.27. Assuming a risk-free rate of 5.02% and a market risk premium of 5%, what is your estimate of the required rate of return for Emerson’s stock using the CAPM?
Return = 5.02% + 1.27* 5%
= 11.37%
(b) What rate of growth in earnings is consistent with Emerson’s policy of paying out 40% of earnings in dividends and the firm’s historical return on equity?
Growth Rate = Return on equity * (1 - Dividend payout ratio )
= 23.72% * (1 - 40%)
=14.23%
(c) Using your estimated growth rate, what is the value of Emerson’s shares using the Gordon growth model?
value of share = ($5.69 *40%) / (11.37% - 14.23% )
= - $79.58
(d) Analyze the reasonableness of your estimated value per share using the Gordon
- The share price is negative because the growth rate is more than the required return
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