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................................................... 3 Objectives: ............................................................................................................................... 3 Literature Review: ................................................................................................................... 4 Research Methodology: ........................................................................................................... 7 Industry Overview ................................................................................................................... 8 6.1 6.2 6.3 6.4 6.5 7. FMCG Industry ................................................................................................................ 8 IT Industry: ....................................................................................................................... 9 Automobile Industry: ..................................................................................................... 13 OIL industry: .................................................................................................................. 17 Banking Industry: ........................................................................................................... 21
Overview of Stock Valuation Models. .................................................................................. 25 7.1 7.2 7.3 7.4 Dividend Discount Model .............................................................................................. 25 The Residual-Income Stock Price Valuation Model ...................................................... 26 Price Earnings Valuation Method .................................................................................. 28 H-model:......................................................................................................................... 29
Descriptive Statistics ............................................................................................................. 31 Analysis and Interpretation .................................................................................................... 32 9.1 9.2 9.3 9.4 Dividend Discount Model: ............................................................................................. 32 Residual Income Valuation Model:................................................................................ 32 Price Earning Model: ..................................................................................................... 32 H-Model: ........................................................................................................................ 33 Conclusion: ........................................................................................................................ 33 References: ......................................................................................................................... 34
1. Executive Summary:
Every investor interested in investing in stock markets wants to know the expected future value of stock they interested to invest, because investor always want to maximize his wealth. So determining stock value is not easy task as lots of factors affect the share prices of company which are not taken into consideration in different models used to determine share prices. Over the period of time many models has been constructed to determine stock price, but unfortunately no models are consistent and uniform in determining prices and no model gives appropriate value as well. So this research is done to check the efficiency of four best rated models across five industries. I have taken Dividend discount model, Residual income valuation model, Price earning model and H- model. 5 companies from five sectors like FMCG, Automobile, Information Technology, Oil and Banking have been taken for analysis. Monthly share prices for 1 year starting from April 2009 to March 2010 have taken from BSE website. After data has been put into excel and all the necessary calculation has been done. GDP growth rate for that period has taken as normal growth rate. Then CAPM model has been applied to find out cost of equity. After that all the share prices for each company has been determined by every model. It has been found that Price earning model is the most successful model and residual income model was successful for banking industry. Dividend discount model and H-model has been proved most inefficient model in stock valuation.
Equity Valuation has always been an enigma even for the most analytically equipped investors or fund manager because numerous factors determine the worth of a stock. A review of business periodicals suggests that valuation models are of interest to the investment community. Different models are proposed and are used by practitioners. Maximizing shareholders value has become the new corporate paradigm in recent years. The Corporate, which gave the lowest preference to shareholders‘ curiosity, are now bestowing the utmost preference to it. Shareholder‘s wealth is measured in terms of returns they receive on their investment. It can either be in forms of dividends or in the form of capital appreciation or both. Capital appreciation depends on the changes in the market value of the stocks. The market value of stocks depends upon number of factors ranging from company specific to market specific. Financial information is used by various stakeholders to assess firm‘s current performance and to forecast the future as well. As there exists a range of models to forecast the value of a stock, we need to know which valuation model gives better results from investor‘s point of view in order to maximize his wealth by investing in stock market. The models exists are Dividend Discount Model, Two Stage Model, Free cash Flow Model, Price-Earning Model, Price-Book Value Model, H Model, Residual Income Model and Economic Value Added Model. So many models exist because investors and fund managers did not get effective results from previous models which lead to a creation of more models. Still investors and Fund Managers are confused among various models as they are getting better results from different model for different stocks. So here an attempt has been taken to find out which model is more effective for which sector in comparison with other models by analyzing the results of all the models mentioned above for various industry taking into consideration all the possible factors affecting stock prices.
To evaluate leading stock valuation models. To identify the model showing more rational valuation. To find out cross sectorial variations for application of valuation models.
4. Literature Review:
Equity shares can be described more easily than fixed income securities. However they are more difficult to analyze. Fixed income Securities typically have limited life and a well-defined cash flow stream, but equity shares have neither. Though the basic principles of valuation are the same for fixed securities and equity shares, but factors like growth and risks create the complexity in case of equity. As research says that identifying mispriced securities is not so easy, but there are chinks in the efficient market hypothesis and hence the search for mispriced securities cannot be dismissed out of hand. Moreover it is known that the ongoing research by group of analysts contributes to a high degree of market efficiency. The empirical studies highlight that there is no single accounting measure which explains the variability in the shareholders wealth (Chen and Dodd, 1997; Rogerson, 1997). Generally analysis of equity can be done in two ways: Fundamental Analysis and Technical Analysis. Fundamental analyst asses the fair market value of equity shares by examining the assets, earnings, cash flow projections, and dividend potential. Fundamental analysts differ from technical analysts who essentially rely on price and volume trends and other market indicators to identify trading opportunities. Several researches has proved that CAPM model has lost its importance in calculating cost of equity as lots of economic factors are directly or indirectly affecting the cost of equity which has been resulting a wide range of range in investor‘s expected rate of return. The Capital Asset Pricing Model postulates a simple linear relationship between expected rate of return and systematic risk of a security or portfolio. The model is an extension of Markowitz‘s (1952) portfolio theory. The researchers who are commonly credited with the development of CAPM are Sharpe (1964), Linter (1965) and Black (1972), which is why CAPM is commonly referred to as SLB model. Markowitz (1952) developed a concept of portfolio efficiency in terms of the combination of risky assets that minimizes the risk for a given return or maximizes return for a given risk. Using variance of expected returns as the measure of risk, he shows a locus of efficient portfolios that minimize risk for a given rate of return. Most empirical examinations of CAPM use realized returns to estimate the β coefficient. The estimation is usually carried out by regressing a securities' excess return (Ri-Rf) on market excess return (Rm-Rf.). In recent years CAPMs ability to predict returns has been found to be negligible [Fama and French (1992, 1993, 1996)]. However, β is still widely acceptable as a measure of risk [Coates, et al. (1995), and
Green et al. (1996)]. As such β is commonly used to estimate Excess Return (ER) and cost of capital. As stated above the CAPM prediction of cost of capital seem to be more realistic than that of DDM. The dividend discount model is also becoming ineffective as most of the companies now a day are not paying dividend to increase their reserve and surplus which leads to an increase in stock prices of that company. Companies paying regular dividend might give better result in dividend discount model. Major criticisms of DDM include the assumption of constant growth (g) and the fact that the model does not allow the cost of capital to exceed the growth rate. The latter is undoubtedly not true for companies with low growth. Another major criticism is that the model does not apply to companies who do not pay dividends. Most companies in the USA do not pay dividends (Baker & Powell, 1999; Keown et al., 2002.) The majority of empirical work regarding DDM involves estimating the cost of capital(k). Geykdajy (1981) examine the trend of the cost of equity for 28 U.S. multinational companies and 28 other domestic U.S. companies over the period of 1965-1978 using the DDM approach based on the anticipated ex-ante dividends. Siegel (1985) derives a simple approximation to estimate the cost of capital using DDM with less restrictive assumptions. The assumptions are: growth rates are constant; dividend yield and growth must be calculated on a yearly basis to estimates yearly costs; and the price is based on ex-dividend quotations. The main results of this study indicate that the cost of capital is sensitive to the choice of data. Scott (1992) measured the real cost of equity capital from 19271987 using DDM. He found the real growth rate of dividends to be the dominant factor that affects the real cost of capital. Cost of capital was estimated to be 4-6% nominally and 1-2% in real terms. Models like Price-Earning also gives better results depending upon the industry P/E ratios. Better result from Price-Book value model directly depends on the net worth of the company. In India Balakrishnan (1984) found that current dividend and book value are the important determinants of market price. Sharma (1989) identified factors that influence P/E ratios in cotton textile firms in India over the period of 1976-80. Barua and Raghunathan(1990) showed that P/E ratios during 1990s were on the higher side using Gordon‘s Model. Gupta (1998) focused on the relationship between P/E ratio and company size.
Two stage models take into consideration the abnormal growth and normal growth to forecast price. Determining abnormal growth rate is a big challenge for a company as in booming scenario market also sometimes growing in abnormal rate. Recent development says that Residual Income model is giving better results as compared to other models for maximum companies. As per RI model the market price should be moving around book value but in reality the market price is higher than book value. Though stock valuation has got several models but role of economy in valuation of stock has huge impact. Company specific fundamentals, Industry specific fundamentals and Economic specific fundamentals play an important role in valuation of stock. So this study is to find out the efficiency of different models for various industries taking into consideration other economic factors.
5. Research Methodology:
For this study data has been taken from Bombay Stock Exchange website and ICICI direct.com. The closing price of all company has been taken for forecasting the value of particular stock. Closing price has been taken monthly for one year ranging from April 2009 to March 2010. Market closing price has also been taken as per company closing price. From each sector like Automobile, Banking, FMCG, Information Technology and Oil data has been collected. One target company has been taken and four more competitor company has been taken on the basis of P/E ratio. After collecting data has been put in Microsoft Excel and all required calculation has been done in excel applying the formulas for each and every model. Sample Size: 25 companies. Period: 1 year. Data Collection: Historical data
6. Industry Overview
6.1 FMCG Industry
The FMCG industry, or alternatively named CPG, abbreviation for Consumer Packaged Goods, deals mainly with the production, distribution as well as marketing of packaged goods for all consumers. The Fast Moving Consumer Goods (FMCG) has to do with those consumables which are regularly being consumed. Among the first activities of the FMCG industry there is selling, marketing, financing, purchasing, and so on. Recently this industry has also launched in operations, supply chain, production, general management, etc. The wide range of consumable goods provided by the FMCG industry turns over a large amount of money, while competition among FMCG manufacturers is become more and more fierce. Investors are putting more and more into the FMCG industry, especially in India, where the FMCG industry is the fourth largest sector, having a total market size of more than US$13.1 billion, and still estimated to double by 2010. In New Zealand as well, the FMCG industry accounts for 5% of Gross Domestic Product (GDP). Some common FMCG product include food and dairy products, glassware, paper products, pharmaceuticals, electronics, plastic goods, printing goods, household products, photography, drinks etc, so here coffee, tea, greeting cards, gifts, detergents, soaps etc are all included. The factors that made the FMCG industry a highly competitive one are low operational cost, solid distribution networks, and emergence of new FMCG companies. In addition, the growth of the world‘s population is another responsible factor for the huge success of this particular industry. Some of the leading FMCG companies all over the world are Sara Lee, Nestlé, Unilever, Procter & Gamble, Coca-Cola, Carlsberg, Kleenex, General Mills, Mars etc. Not only does it provide the necessary goods for day to day life, but the FMCG industry has also created tremendous job opportunities and careers. It is a stable, varied, and highly profitable industry, and the jobs it provide range from sales, supply chain, finance, marketing, operations, human resources, development, general management, and so on.
The Rs.85,000 crore FMCG market in India is growing at a fast pace despite of the economic downtrend. The increasing disposable income and improved standard of living in most tier II and tire III cities are spearheading the FMCG growth across the nation. The changing profile and mind set of the consumers has shifted the thought to ―Value for Money‖ from ―Money for Value‖. Over the years companies like HUL, ITC and Dabur have improved performance with innovation and strong distribution channels. Their key categories have strengthened their presence and out performed peers in the FMCG sector. On the contrary, Colgate Palmolive and Britannia Industries are strong in single product category i.e. tooth pastes and Biscuits. In addition companies have been successful in reviving their presence in the semi-urban and rural markets.
The Indian information technology (IT) industry has played a major role in placing India on the international map. The industry is mainly governed by IT software and facilities for instance System Integration, Software experiments, Custom Application Development and Maintenance (CADM), network services and IT Solutions. According to Nasscom's findings Indian IT-BPO industry expanded by 12% during the Fiscal year 2009 and attained aggregate returns of US$ 71.6 billion. Out of the derived revenue US$ 59.6 billion was solely earned by the software and services division. Moreover, the industry witnessed an increase of around US$ 7 million in FY 2008-09 i.e. US$ 47.3 billion against US$ 40.9 billion accrued in FY 2008-09. As per NASSCOM, IT exports in business process outsourcing (BPO) services attained revenues of US$ 48 billion in FY 2008-09 and accounted for more than 77% of the entire software and services income. Over the years India has been the most favorable outsourcing hub for firm on a lookout to offshore their IT operations. The factors behind India being a preferred destination are its reasonably priced labor, favorable business ambiance and availability of expert workforce. Considering its escalating growth, IBM has plans to increase its business process outsourcing (BPO) functions in India besides employing 5,000 workforces to assist its growth.
India's domestic IT Market over the years has become one of the major driving forces of the industry. The domestic IT infrastructure is developing contexts of technology and intensity of penetration. In the FY 2008-09, the domestic IT sector attained revenues worth US$ 24.3 billion as compared to US$ 23.1 billion in FY 2007-08, registering a growth of 5.4%. Moreover, the increasing demand for IT services and goods by India Inc has strengthened the expansion of the domestic market with agreements worth rising up extraordinarily to US$ 100 million. By the FY 2012, the domestic sector is estimated to expand to US$ 1.7 billion against the existing from US$ 1 billion. The Indian IT sector persists to be one of the flourishing sectors of Indian financial system indicating a speedy expansion in the coming years. As per NASSCOM, the Indian IT exports are anticipated to attain US$ 175 billion by 2020 out of which the domestic sector will account for US$ 50 billion in earnings. In total the export and domestic IT sector are expected to attain profits amounting to US$ 225 billion along with new prospects from BRIC nations and Japan for its outsourcing operations. According to a research report published by National Association of Software and Service Companies (NASSCOM), ‗IT-BPO Sector in India: Strategic Review 2010,‘ the IT-BPO industry is estimated to aggregate revenues of US$ 73.1 billion in FY2010, with the IT software and services industry accounting for US$ 63.7 billion of revenues. The report estimates export revenues to gross US$ 50.1 billion in FY2010, growing by 5.4 per cent over FY2009, and contributing 69 per cent of the total IT-BPO revenues. Software and services exports (including BPO) are expected to account for over 99 per cent of total exports, employing around 1.8 million employees. IT services is expected to grow by 2.4 per cent in 2010, and 4.2 per cent in 2011 as companies coming out of recession harness the need for information technology to create competitive advantage. NASSCOM said that the domestic IT-BPO is expected to grow by 15-17 per cent during FY11. According to NASSCOM, the industry will witness a healthy growth in 2010, led by growth in the core markets and supplemented by significant contributions from emerging markets. Growth
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drivers include a thrust on platform BPO, Analytics, Finance & Accounting, Remote Infrastructure Management, ADM, and Cloud Services. The annual survey on the outlook for FY10-11 said that the growth in the domestic IT-BPO spend is driven by a robust economy, increased IT spending by government and adoption of IT by SMBs. The data centre services market in the country is forecast to grow at a compound annual growth rate (CAGR) of 22.7 per cent between 2009 and 2011, to touch close to US$ 2.2 billion by the end of 2011, according to research firm IDC India's report published in March 2010. The IDC India report stated that the overall India data centre services market in 2009 was estimated at US$ 1.39 billion. India will see its number of internet users triple to 237 million by 2015, from 81 million registered in September 2010, according to a report titled 'Internet's New bn', by the Boston Consulting Group (BCG). BCG said Internet penetration rate in India is expected to reach 19 per cent by 2015, up from the current seven per cent. TRAI said on December 7, 2010 that it was targeting a 10-fold increase in broadband subscribers to 100 million by 2014. The country has 10.29 million subscribers now. "We will have 100 million broadband subscribers by 2014," J.S. Sarma, Chairman, Telecom Regulatory Authority of India (TRAI) said at the fifth India Digital Summit 2010 organised by the Internet and Mobile Association of India. Investments Between April 2000 and September 2010, the computer software and hardware sector received cumulative foreign direct investment (FDI) of US$ 10,406.16 million, according to the Department of Industrial Policy and Promotion. The total investments of EMC Corporation, a leading global player of information infrastructure solutions in India, will touch US$ 2 billion (over US$ 2.01 billion) by 2014. Syntel, an IT company, plans to invest around US$ 50 million in its global development centre in Chennai.
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Russian IT security software provider, Kaspersky Lab, will be investing US$ 2 million in its India operations at Hyderabad during the next financial year. Government Initiatives The government has constituted the Technical Advisory Group for Unique Projects (TAGUP) under the chairmanship of Nandan Nilekani. The Group would develop IT infrastructure in five key areas, which includes the New Pension System (NPS) and the Goods and Services Tax (GST) The government set up the National Taskforce on Information Technology and Software Development with the objective of framing a long term National IT Policy for the country Enactment of the Information Technology Act, which provides a legal framework to facilitate electronic commerce and electronic transactions Setting up of Software Technology Parks of India (STPIs) in 1991 for the promotion of software exports from the country, there are currently 51 STPI centres where apart from exemption from customs duty available for capital goods there are also exemptions from service tax, excise duty, and rebate for payment of Central Sales Tax. But the most important incentive available is 100 per cent exemption from Income Tax of export profits, which has been extended till 31st March 2011 Government is also setting up Information Technology Investment Regions (ITIRs). These regions would be endowed with excellent infrastructure and would reap the benefits of co-siting, networking and greater efficiency through use of common infrastructure and support services Moreover, according to NASSCOM government, IT spend was US$ 3.2 billion in 2009 and is expected to reach US$ 5.4 billion by 2011. Further, according to NASSCOM, there is US$ 9 billion business opportunity in e-governance in India. Road Ahead The Indian information technology sector continues to be one of the sunshine sectors of the Indian economy showing rapid growth and promise.According to a report prepared by McKinsey for NASSCOM called 'Perspective 2020: Transform Business, Transform India' released in May
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2009, the exports component of the Indian industry is expected to reach US$ 175 billion in revenue by 2020. The domestic component will contribute US$ 50 billion in revenue by 2020. Together, the export and domestic markets are likely to bring in US$ 225 billion in revenue, as new opportunities emerge in areas such as public sector and healthcare and as geographies including Brazil, Russia, China and Japan opt for greater outsourcing.
With a scintillating 2.3 million units produced in 2008 the Indian automobile industry bagged the position of being the ninth largest in the world. Following economic liberalization, Indian domestic automobile companies like Tata Motors Maruti Suzuki and Mahindra and Mahindra expanded their production and export operations in and across the country and since then the industry has only shown signs of growth. The automobile industry comprises of heavy vehicles (trucks, buses, tempos, tractors), passenger cars, and two-wheelers. The Indian automobile industry seems to come a long way since the first car that was manufactured in Mumbai in 1898. The automobile sector today is one of the key sectors of the country contributing majorly to the economy of India. It directly and indirectly provides employment to over 10 million people in the country. The Indian automobile industry has a well established name globally being the second largest two wheeler market in the world, fourth largest commercial vehicle market in the world, and eleventh largest passenger car market in the world and expected to become the third largest automobile market in the world only behind USA and China. The growth of the Indian middleclass along with the growth of the economy over the last few years has resulted in a host of global auto giants setting their foot inside the Indian Territory. Moreover India also provides trained manpower at competitive costs making the country a manufacturing hub for many foreign automobile companies. India proves to be a potential market as compared to most of the other countries which are witnessing stagnation as far as automobile industry growth is concerned.
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A recent research conducted by the global consultancy firm Deloitte says that at least one Indian automobile company will feature among the top six automobile companies that will dominate the car market by 2020. The Indian automobile industry proved to be in good shape last year even after the economic downturn. This was majorly due to the fact of renewed interest shown by global automobile players like Nissan Motors which consider India to be a potential market. As far as authorized dealer networks and service stations are concerned Maruti Suzuki is the most widespread. The other automobile companies are also showing rapid progression in this field. The automobile sector of India is the seventh largest in the world. In a year, the country manufactures about 2.6 million cars making up an identifiable chunk in the world‘s annual production of about 73 million cars in a year. The country is the largest manufacturer of motorcycles and the fifth largest producer of commercial vehicles. Industry experts have visualized an unbelievably huge increase in these figures over the immediate future. The figures published by the Asia Economic Institute indicate that the Indian automobile sector is set to emerge as the global leader by 2012. In the year 2009, India rose to be the fourth largest exporter of automobiles following Japan, South Korea and Thailand. Experts state that in the year 2050, India will top the car volumes of all the nations of the world with about 611 million cars running on its roads. At present, about 75 percent of India‘s automobile industry is made up by small cars, with the figure ranking the nation on top of any other country on the globe. Over the next two or three years, the country is expecting the arrival of more than a dozen new brands making compact car models. Recently, the automotive giants of India including General Motors (GM), Volkswagen, Honda, and Hyundai, have declared significant expansion plans. On account of its huge market potential, a very low base of car ownership in the country estimated at about 25 per 1,000 people, and a rapidly surging economy, the nation is firmly set on its way to become an outsourcing platform for a number of global auto companies. Some of the upcoming cars in the India soil comprise
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Maruti A-Star (Suzuki), Maruti Splash (Suzuki), VW Up and VW Polo (Volkswagen), Bajaj small car (Bajai Auto), Jazz (Honda) and Cobalt, Aveo (GM) in addition to several others. According to SIAM, the total automobile sales in the domestic market was reported 1114157 units in January , increasing by 44.9% while for the same period last year 7,68,698 units were reported sold. Car sales in January saw a growth of 32% as it was reported 145000 units in the first month of 2010. The data for car sales surprised the analysts as it beats the previous best of 133000 sales recorded in November 2009, according to the data released by SIAM. "This is the highest ever sales by the auto industry and has come on the back of economic growth, reduced interest rates and better money supply in the system," Dilip Chenoy, director general, SIAM said. Chenoy did not forget to say that the high growth in January was also contributed by last year's low base as well as reduced commodity prices. While analysts in the industry see the low interest rates for car loans and economic recovery as important factors for this growth. Analysts also said fear of a hike in taxes in the Union Budget also aided the growth. Now the expectations are there by the industry experts that the total domestic industry will end the current financial year at over 11 million units, which will be a growth of 22.6% over 2008-09. Domestic Market/ Sales: India‘s auto market grew at 32.69 per cent in 2010, marginally better than China‘s 32.44 per cent, according to SIAM. According to the data released by SIAM, in December 2010, total sale of vehicles across categories registered a growth of 30.51 per cent to 13,05,872 units, as against 10,00,562 units in the same month of 2009. The industry has been growing at around 30 per cent in the ongoing fiscal. According to data released by SIAM, the passenger vehicles segment during April-December 2010 grew at 31.83 per cent over same period last year. Passenger cars grew by 32 per cent,
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utility vehicles grew by 20.82 per cent and multi-purpose vehicles grew by 50.58 per cent during this period. The overall commercial vehicles segment registered a growth of 34.08 per cent during AprilDecember 2010, as compared to the same period last year. While medium and heavy commercial vehicles registered growth of 42.85 per cent, light commercial vehicles grew at 27.12 per cent. Two wheelers registered a growth of 28.21 per cent during April-September 2010. Mopeds, scooters and motorcycles grew by 24.47 per cent, 48.90 per cent and 24.62 per cent, respectively. Road Ahead: Global auto companies are investing to tap the growing demand in India as investment spending and the government's social programmes raise incomes in smaller cities and rural areas too. "The Indian automobile industry is geared up to invest up to US$ 17.12 billion in fresh capacity in the next four years," Vishnu Mathur, Director-General, SIAM said. He further stated, "The components industry will also invest US$ 12 billion up to the end of the Automotive Mission Plan." Car and motorcycle sales in India are setting records with rising incomes, cheap lending by banks and launch of new models such as Volkswagen's Polo and Fiat's Linea. Car manufacturing capacity is set to rise to 5.7 million units by 2015, according to consultants Ernst & Young. Further, India aims to become the small car hub of the world by dethroning Japan, the biggest maker of compact cars, a majority of which is consumed domestically. Last year, it had pipped Brazil to become the second-largest producer of such cars. Passenger vehicle production is expected to grow to 9 million a year in 2020, while two-wheeler production will touch 30 million, said B.S. Meena, secretary, department of heavy industries. According to the annual forecast of the SIAM, passenger vehicle sales in the country will be 21,96,791 units in 2010-11 as compared to 19,49,248 units in 2009-10. While two-wheeler sales are expected to be up 9-10 per cent at 10,287,837 units from 9,368,230 units in 2009-10, commercial vehicle sales in India will grow 17-18 per cent at 6,21,681 units
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vis-à-vis 5,31,395 units last financial year. Sales of three-wheelers are expected to go up 7-8 per cent at 4,73,693 units in the current financial year as against 4,40,368 units in 2009-10. However, with demand outgrowing the supply in the market, the overall market growth for 201011 is most likely to exceed SIAM's initial prediction of 10-14 per cent.
The oil and gas industry has been instrumental in fuelling the rapid growth of the Indian economy. India has total reserves (proved & indicated) of 1,201 million metric tons (MMT) of crude oil and 1,437 billion cubic meters (BCM) of natural gas as on April 1, 2010, according to the basic statistics released by the Ministry of Petroleum and Natural Gas. The country exported 50.974 MMT of petroleum products during 2009-10. In the eighth round of the New Exploration Licensing Policy (NELP-VIII), 1.62 sq km area will be covered comprising 70 blocks. Out of 70 blocks, 36 have been awarded under NELP-VIII, according to the Economic Survey 2009-10. Mr Murli Deora, Union Minister of Petroleum & Natural Gas has launched the ninth round of NELP (NELP-IX) in New Delhi on October 15, 2010. NELP-IX round offers 34 exploration blocks comprising of 8 deepwater blocks, 7 shallow water blocks and 19 on land blocks. Moreover, the government is planning its first ever offer of shale gas exploration in 2012. According to Mr Deora, "Shale gas (gas locked in sedimentary rocks) is an emerging area. It has become an important source of energy in a few countries who have been able to commercially exploit this resource." Production By the end of the Eleventh Plan, the refinery capacity is expected to reach 240.96 million metric tons per annum (MMTPA). As per Mr Jitin Prasada, Minister of State for Petroleum & Natural Gas, the refining capacity of the oil refineries in the country has undergone nearly a three-fold increase from 62 MMTPA in April, 1998 to 184 MMTPA in April, 2010.
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According to the provisional data released by the Ministry of Petroleum & Natural Gas, dated November 26, 2010: During April-October 2010, crude oil production reached 21.542 MMT, as compared to 19.457 MMT in the corresponding period in 2009 During April-October 2010, 93.58 MMT of crude oil was refined, as compared to 92.25 MMT in April-October 2009 During April-October 2010, the actual natural gas production was 31.0 BCM, as compared to 25.4 BCM in the corresponding period in 2009 Consumption The consumption of petroleum products during 2009-10 were 138.196 MMT (including sales through private imports) an increase of 3.60 per cent over sales of 133.4 MMT during 2008-09, according to the Ministry of Petroleum. According to estimates of the Petroleum Planning and Analysis Cell (PPAC), the consumption of fuels in the current financial year (2010-11) will be at 146.08 million tons (MT) up from 138.2 MT in the last fiscal. The estimates show that diesel consumption in the current fiscal may see an increase of 8.8 per cent at 61.26 MT compared with 56.3 MT in the last fiscal, while petrol sales were expected to go up by 12.8 per cent to 14.45 MT from 12.8 MT. Availability of natural gas, including imported LNG, is likely to increase in the country by over 52 per cent to 271.92 million cubic meters a day by 2013-14, said Mr. Deora. "At present, total availability of natural gas in India, including liquedified natural gas (LNG), is around 167.80 mmcmd, which is projected to be around 202.97 mmcmd, 256.6 mmcmd and 271.92 mmcmd during 2011-12, 2012-13 and 2013-14 respectively," stated the Union Minister of Petroleum & Natural Gas. To capture the opportunity presented by the impending gas surge in India, Gas Authority of India Ltd (GAIL) is investing significantly in its pipeline network. Over the next three years, it will
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invest US$ 660.7 million-US$ 770.8 million, expanding its transmission capacity from the current 150 MSCMD to 300 MSCMD. Moreover, GAIL which has signed a Memorandum of Understanding (MoU) with the Karnataka government will spend US$ 423.6 million this year to lay the 800-km pipeline to transport gas from the LNG terminal in Dabhol to Bidadi near Bangalore. GAIL expects the project to be completed by March 2012. Recently, Punj Lloyd Group has bagged a US$ 87.57 million contract from GAIL India for laying a natural gas pipeline from Dabhol to Bangalore. Further, GAIL has commenced construction of its Karanpur–Moradabad–Kashipur–
Rudrapur/Pant Nagar natural gas pipeline at Kashipur, Uttarakhand. The estimated investment on the project is US$ 40.22 million. State-owned Oil and Natural Gas Corp (ONGC) has said that its natural gas output will rise by over 58 per cent to 100 million cubic meters a day by 2015-16 after it puts its eastern offshore fields into production, said R S Sharma, Chairman and Managing Director, ONGC. Natural gas production will rise to 72 million standard cubic meters per day (MMSCMD) in 2012-13 from 63 MMSCMD in 2009-10. The US Overseas Private Investment Corporation (OPIC) will provide US$ 100 million in financing for the US$ 300 million South Asia Energy Fund, part of the Global Environment Fund (GEF). The South Asia Energy Fund will invest in solar, wind, hydropower, advanced biofuels and natural gas projects, with focus on Indian investment. GSPC Gas Company Ltd, a gas distribution arm of state-run Gujarat State Petroleum Corporation (GSPC), has set the target of achieving 300,000 piped natural gas (PNG) connections by 2012. The company currently has 192,000 PNG connections across Gujarat. Investments In a major boost for investment in the petrochemical sector, the Ministry of Chemicals and Fertilisers has approved a proposal of investments worth US$ 25.25 billion in three regions under its flagship petroleum chemicals and petrochemicals investment regions (PCPIR) policy.
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The investment includes US$ 7.32 billion for physical infrastructure development, and the rest is project-specific investments committed by various public and private companies in three PCPIRs — Visakhapatnam and East Godavari districts in Andhra Pradesh, Bharuch in Gujarat and East Midnapore in West Bengal. US-based industrial gases company Praxair has decided to invest about US$ 370.74 million into its India operations, said Gajanan Nabar, Managing Director, Praxair India. Chennai Petroleum Corporation Limited (CPCL) plans to invest around US$ 3.39 billion for the next five years for capacity expansion including a brownfield refinery project at Manali near Chennai with an outlay of US$ 1.69 billion. Essar Oil plans to expand its refinery capacity by 2 million tons a year at Vadinar in Gujarat with an investment of US$ 278. 46 million. The company will increase its capacity to 20 million tonne by 2012. According to Mr S. Sundareshan, Secretary, Petroleum and Natural Gas, public sector oil companies are going to be the major investors in Kerala over the next two years as they have earmarked over US$ 1.61 billion investments in the State. State-owned refiner-marketer Hindustan Petroleum plans to invest US$ 4.87 billion into a new refinery with a capacity of 18 million tons per year in Maharashtra. Government Initiatives The government has been taking many progressive measures to create conducive policy and regulatory framework for attracting investments. FDI up to 100 per cent under the automatic route is permitted in exploration activities of oil and natural gas fields, infrastructure related to marketing of petroleum products, actual trading and marketing of petroleum products, petroleum product pipelines, natural gas and LNG pipelines, market study and formulation and petroleum refining in the private sector. FDI up to 49 per cent is permitted under the government route in petroleum refining by the public sector undertakings (PSU) according to the Consolidated Foreign Direct Investment (FDI) Policy document by the Department of Industrial Policy and Promotion.
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Vision-2015 approved in 2009, for the oil sector which will focus on expanding the marketing network as well as quality of the products and services to customers covering four broad areas of LPG (liquefied petroleum gas), kerosene, auto fuels and compressed natural gas/piped natural gas. In 2009, the government announced a seven-year tax holiday for commercial production of gas in respect of contract to be signed under NELP VIII & Coal Bed Methane (CBM) IV with a view to give a boost to exploration and production according to a press release by the Ministry of Petroleum and Natural Gas. To arrive at a viable and sustainable system of pricing of petroleum products, the Government had set up an Expert Group and on its recommendation the Government has decided that the pricing of petrol and diesel both at the refinery gate and the retail level will be marketdetermined as per a press release by the Ministry of Petroleum and Natural Gas.
The banking system remains, as always, the most dominant segment of the financial sector. Indian banks continue to build on their strengths under the regulator's watchful eye and hence, have emerged stronger. In the annual international ranking conducted by UK-based Brand Finance Plc, 18 Indian banks have been included in the Brand Finance® Global Banking 500. In fact, the State Bank of India (SBI) which is the first Indian bank to be ranked among the Top 50 banks in the world, has improved its position from 36th to 34th, as per the Brand Finance study released on February 1, 2011. The brand value of SBI has enhanced to US$ 1,119 million. ICICI Bank, the only other Indian bank in the top 100 club has improved its position with a brand value of US$ 2,501 million. According to the study, Indian banks contributed 1.7 per cent to the total global brand value at US$ 14,741 million and grew by 19 per cent in 2011. According to RBI's 'Quarterly Statistics on Deposits and Credit of Scheduled Commercial Banks: June 2010', nationalized banks, as a group, accounted for 51.3 per cent of the aggregate deposits, while State Bank of India (SBI) and its associates accounted for 22.8 per cent. The
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share of new private sector banks, Old private sector banks, Foreign banks and Regional Rural banks in aggregate deposits was 13 per cent, 4.8 per cent, 5.1 per cent and 3.1 per cent respectively. With respect to gross bank credit also, nationalized banks hold the highest share of 51.5 per cent in the total bank credit, with SBI and its associates at 23.2 per cent and New Private sector banks at 13 per cent. Foreign banks, Old private sector banks and Regional Rural banks held relatively lower shares in the total bank credit with 5.3 per cent, 4.6 per cent and 2.5 per cent respectively. The report also found that scheduled commercial bank offices (with deposits of INR 10 crore or more) accounted for 65.2 per cent of the bank offices, 96.6 per cent in terms of aggregate deposits and 94 per cent in total bank credit. Significantly, on a year-on-year basis, bank credit grew by 24.4 percent in 2010 as against RBI‘s projections of 20 percent for the entire fiscal 2010-11. However, deposits lagged behind at 16.5 percent versus a projection of 18 percent. India's foreign exchange reserves stood at US$ 299.39 billion as on January 21, 2011, according to the data in the weekly statistical supplement released by the Reserve Bank of India. Indians working overseas sent more money back home than any of their global counterparts, remitting US$ 50 billion in 2009 despite a worldwide economic slowdown and anti-immigration measures adopted by industrialized countries. Major Developments Indian Bank has received the Central Bank of Sri Lanka's nod to open its branch at Jaffna in Sri Lanka. Indian Bank has signed an agreement with Weizmann Forex Ltd, and will now offer foreign remittances service over the counter at all its branches. The National Payment Corporation of India is rolling out an instant interbank mobile payment service (IMPS) that will enable retail customers of seven banks to enjoy 24X7 funds transfer. State Bank of India, Bank of India, Union Bank of India, ICICI Bank, HDFC Bank, Axis Bank and YES Bank on November 22, 2010 became the first set of banks to go live with the IMPS.
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Amongst the private banks, owing to strong growth in interest income, the country‘s third-largest private sector lender, Axis Bank, reported a net profit of US$ 166.3 million for the second quarter of FY11, a 38.28 per cent increase from US$ 120.3 million a year ago. HDFC Bank, India‘s second largest private lender reported a 32.7 percent rise in net profits at US$ 204.3 million for the quarter ended September 30, 2010. The Cabinet, on December 1, 2010 approved to provide an additional amount of US$ 1.33 billion, in addition to the US$ 3.32 billion already provided in the Budget 2010-11, to ensure Tier I CRAR (Capital to Risk Weighted Assets) of all Public Sector Banks (PSBs) at 7 per cent and also to raise Government of India holding in all PSBs to 58 per cent. It also approved that the exact amount, mode of capitalization and other terms and conditions would be decided in consultation with the banks at the time of infusion. The proposed capital infusion would enhance the lending capacity of the PSBs to meet the credit requirement of the economy in order to maintain and accelerate the economic growth momentum. The RBI has allowed banks to make changes in the repayment schedules or drawdown without prior approval from the central bank. However, such a change could be made on the condition that the average maturity of the loan should remain the same. The move is expected to make external commercial borrowing (ECB) transactions easier. Transactions both through automatic and approval routes can take advantage of this change. Now, without the prior approval of RBI, Indian companies may borrow up to US$ 500 million in a year. As part of further liberalization of the extant branch licensing policy in respect of regional rural banks (RRBs), they have been permitted to open branches in Tier 3 to Tier 6 centers (with population up to 49,999 as per Census 2001) without the Reserve Bank's prior authorization provided The capital to risk-weighted assets ratio (CRAR) is at least 9 per cent; The net non-performing assets (NPAs) are less than 5 per cent; They have not defaulted in the maintenance of cash reserve ratio (CRR)/statutory liquidity ratio (SLR) during the last year; and
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They have earned a net profit in the last financial year.
On the lending side, the Base Rate system replaced the Benchmark Prime Lending Rate (BPLR) system with effect from July 1, 2010. Base Rates of scheduled commercial banks (SCBs) were fixed in the range of 5.50-9.00 per cent. Subsequently, several banks reviewed and increased their Base Rates in the range of 10–50 basis points by October 2010. Base Rates of major banks, accounting for over 94 per cent in total bank credit, are in the range of 7.50-8.50 per cent. Banks have also raised their BPLRs in the range of 25-75 basis points for their old loans. As at end-July 2010, around 70,000 branches of 98 banks had participated in the national electronic funds transfer (NEFT) system and the volume of transactions processed increased to 9.5 million in July 2010. In the central bank's Third Quarter Review of Monetary Policy 2010-11, RBI Governor D Subbarao has said that the repo rate and reverse repo rates would be increased by 25 basis points under the liquidity adjustment facility (LAF) with immediate effect. Repo rate increased from 6.25 per cent to 6.5 per cent while reverse repo rate has been raised from 5 per cent to 5.25 per cent. The cash reserve ratio (CRR) of scheduled banks has been retained at 6.0 per cent of their net demand and time liabilities (NDTL). On the basis of an assessment of the current liquidity situation, the RBI also decided to extend additional liquidity support up to April 8, 2011 to scheduled commercial banks under the LAF to the extent of up to 1 per cent of their net demand and time liabilities (NDTL), which was set to expire on January 28, 2011.
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7. Overview of Stock Valuation Models.
Dividend Discount Model
The DDM is the simplest present value approach to valuating common stocks. It estimates the company value based on the idea that the value of the equity equals all future dividends discounted back to today. Gordon Growth Model or Constant Growth Model: The Gordon Growth model (Constant Growth Model) relies on the principle that dividends grow indefinitely at a constant rate. Use this model if your stock meets the following criteria: • It pays out 90% or more of its Net Income in dividends. • Its leverage is expected to remain stable into the future. • Its growth rates are expected to be comparable to or lower than the economy‘s nominal growth rate.
P0 = D0 (1+g) / (1+ke) + D0 (1+g) 2 / (1+ke) 2 + ………..+ D0 (1+g)n / (1+ke)n
This equation is a geometric series that can be simplified algebraically into:
P0 = D0 (1+g) / (ke – g) or P0 = D1/ (ke – g)
Where D1= Expected dividends next year
ke = Cost of Equity
g = Growth rate in dividends forever P0 = Value of a share of stock today The implied dividend growth rate g equals the earning retention ratio (b) times the return on equity (ROE). g = b × ROE Where g = dividend growth rate b = earnings retention rate (1 – dividend payout ratio)
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ROE = return on equity Here the assumption is very strong because we are using the concept of sustainable growth rate as the rate of dividend (and earnings) growth that can be sustained for a given level of return on equity, keeping the capital structure constant over time.
The cost of equity can be found using the Capital Asset Pricing Model. The CAPM equation is as follows:
ke = Rf + ( Rm - Rf ) * β
Rf = the risk free rate (typically prevailing interest rate in market or PPF rate)
Beta (β) = A measurement of a stocks return relative to the market. This is a measurement of systematic risk.
Rm - Rf = the historically accepted risk premium Rm = The market rate of return of stock.
The Residual-Income Stock Price Valuation Model
The residual-income stock price valuation model has received considerable academic attention during the past several years. It is theoretically equivalent to the discounted "free-cash-flows-toequity" model taught in finance courses, as well as the original dividend discount model from which both are derived. The model expresses total common equity value (P) as the sum of the book value of stockholders' equity (BV) and the present value of expected residual-income (RI), as follows P0 = BV0 + RI0 (1+g) / (1+ke) + RI0 (1+g) 2 / (1+ke) 2 +………+ RI0 (1+g) n / (1+ke) n Where P0 is total common equity value. BV0 is the book value of shareholders equity.
ke is the cost of equity capital,
RI is residual-income,
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Where RI = EPS-BV*ke RI = (ROE – ke) * BV Residual income is net income after tax, In this model, RI is defined as the difference between reported net income and the product of (BV) and the firm's cost of equity capital (r). This latter product is the level of income that would be expected for the firm given the book value of its shareholders' equity and the riskiness of its industry. RI can be positive or negative. As a result, if the firm is expected to report abnormally positive income, then its total common equity value will be greater than the book value of stockholders' equity and the converse if expected profits are abnormally low.'' This model is equivalent to the discounted "free-cash-flows-to-equity" (DCF) model commonly taught in finance courses. Both are derived from the underlying assumption that total common equity value is equal to the present value of expected dividends. The free-cash-flow model merely defines dividends in terms of free cash flows and the residual-income model defines them in terms of residual earnings. A considerable amount of research has been conducted during the past several years to compare the ability of the RI and DCF valuation approaches to predict common stock price. On balance, the RI model has been shown to be more accurate than the DCF or the original dividend discount models in estimating stock prices. A side from a possible advantage in pricing, however, the RI valuation model provides a useful framework within which to learn the subject of ratio analysis. It is to this subject that I now turn. This Model can be interpreted as follows So far as ROE > ke, any increment in the equity component or reserve and surplus the residual income will increase. If there is a constraint and limitation on increasing book value we can increase residual income by enhancing ROE and reducing the cost of equity. The primary reference for the value is the book value. In other words the market price should be moving around book value, but in reality the market price is higher than book value.
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The value of the stock as per the residual income model depends upon the investment period and the expected rate of return.
Price Earnings Valuation Method
The price earnings ratio (PE) is a widely watched measure of how much the market is willing to pay for Re.1 of earnings from a firm. A high PE has two interpretations: A higher than average PE may mean that the market expects earnings to rise in the future. A high PE may indicate that the market thinks the firm‘s earnings are very low risk and is therefore willing to pay a premium for them. The PE ratio can be used to estimate the value of a firm‘s stock. Firms in the same industry are expected to have similar PE ratios in the long run. The value of a firm‘s stock can be found by multiplying the average industry PE times the expected earnings per share. P0 = P/E (industry) x EPS (target company)
P/E = market price / EPS.
For stock valuation the composite P/E of particular industry is taken. The average industry PE ratio for restaurants similar to Applebee‘s is 23. What is the current price of Applebee‘s if earnings per share are projected to be $1.13? P0 = P/E (industry) x EPS (target company) P0 = 23 x $1.13 = $26. Advantages: Useful for valuing privately held firms and firms that do not pay dividends.
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Disadvantages: By using an industry average PE ratio, firm-specific factors that might contribute to a long-term PE ratio above or below the average are ignored.
The Gordon growth model implicitly assumes that growth will be stable forever. However, many companies grow at a faster than normal rate before slowing to this stable condition. In such cases, investors can use a multi-stage dividend discount model wherein the Gordon growth model is used to estimate the value once the company matures, but where interim cash flows are estimated using some other method. One such method is the H-model. The H-Model assumes that growth begins at some super-normal rate, then the growth rate declines in a linear fashion until it reaches the normal rate. Under the H-Model, P0 = D0(1 + gt)/(r – gt) + D0H(gs – gt)/(r – gt). The left side of the equation is the Gordon growth model discounted to the present from time t. gt is the growth rate at time t. gs is the current super growth rate and H is the half-life of the expected high growth period. Consider a potential investment in Rockwell Automation (ROK). It pays a current dividend of $1.16 per share and ultimately its growth is likely to slow to the 7% historical average of the S&P 500. However, its growth rate over the last five years has been 36%. Suppose an investor with a 10% required return believes Rockwell‘s growth will slow from that pace to the 7% rate over the course of 10 years. How much would that investor be willing to pay for a share of ROK today? Using the H-Model, Value = $1.16(1.07)/ (0.10 – 0.07) + (1.16 * 5)(0.36 – 0.10)/(0.10 – 0.07) Or Value = $1.24/0.03 + ($5.80 * 0.26)/0.03 = $41.33 + $50.26 = $91.59. This compares with a current share price of $69.00, which could indicate one (or more) of several things:
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Rockwell Automation is undervalued The initial (super) growth rate estimate is too high The estimated high growth period is too long The market requires a higher return than 10% The terminal growth rate will be less than 7%
By running the model, the investor can pinpoint where his or her own views may differ from those of the consensus. For example, the initial growth rate could be too high because analysts currently expect just 18% growth next year and a five-year average of 14% going forward.
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8. Descriptive Statistics
As on 31st March 2010
Infosys HCL TCS Wipro Iflex 101.13 15.57 28.62 33.36 78.81 25 4 20 6 0 384.02 72.69 76.72 120.49 498.15
EPS DPS Book Value
ITC EPS DPS Book VALUE 10.64 10 36.69
HUL 10.09 6.5 11.84
Dabur 4.99 2 8.64
P&G 55.38 22.5 164.7
Britannia 48.77 25 165.86
IOCl EPS DPS Book value SBI EPS DPS Book value 144.37 30 1,038.76
42.1 13 208.21
78.39 33 408.08
PNB BOI BOB CBI 123.86 33.15 83.96 24.87 22 7 15 2.2 514.77 243.75 414.71 107.96
EPS DPS Book Value
TATA Motors Maruti Mahindra Hero honda Bajaj 39.26 86.45 36.89 111.77 117.69 15 6 9.5 110 40 259.03 409.65 138.02 173.52 202.4
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9. Analysis and Interpretation
9.1 Dividend Discount Model:
The dividend discount model has been applied for all of the twenty five companies from automobile sector, IT sector, FMCG sector, Oil sector and banking sector to calculate the share prices of those companies. Here it was seen that cost of equity is less than the normal or expected growth. So prices have come in negative, but if we ignore the negative sign then also it has failed to calculate proper share prices for all of the companies. It has only been successful for Central Bank of India as cost of equity for central bank was very high. So overall analysis says that as for most of the companies cost of equity less than the normal growth Dividend Discount Model has failed to determine desirable result and subsequently losses its importance as share valuation model in recent days.
Residual Income Valuation Model:
The second valuation model applied for all the companies is residual income valuation model. This model gives good result when companies give importance book value of share to determine share prices. Here I have found that residual income model performed well for banking sector and oil sector. That means these companies from banking and oil sector giving importance to their share book values and they have increased their ROE to get more residual income. For other sector like FMCG, IT and automobile Residual income valuation model has failed badly to calculate share prices. These companies ROE is very less and book value is not at all their concern.
Price Earning Model:
The price earning model is one of the valuation models where P/E ratio of industry is taken to determine the share prices. This model has been very successful across the industry in determining share prices. This is the only model which has given near about perfect result for all of the companies of various sectors. That means all the industry is very much concerned about
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their EPS and they are trying to go along with industry P/E ratio. That means companies have set industry P/E as a benchmark of their performance.
H model is one of the models where both normal and abnormal growth rate is taken into consideration. As here we have taken company growth rate as abnormal growth rate and GDP growth rate of that period as normal growth rate. But again like DDM the main problem was cost of equity was less than the normal growth rate. So value has come negative. So this model has only been successful for Central Bank of India and it has given near about perfect value for that bank. For all other companies from different sector H-model has failed badly in determining share prices.
So at the end it is concluded that Dividend discount model and H-Model are no longer efficient in calculating share prices. Residual income model is successful for companies those who have better ROE and giving importance in book value of shares. Price earning model has been successful in determining perfect share prices across the industries. So it has been found that Price earning model is the best model in calculating share prices and to some extent Residual income model for industry like banking.
After analyzing all the models for five industries that no models are perfect in determining share prices for any company as no models gives the perfect value. Models are taking growth, dividend, residual income, EPS; Book value etc. which are generally company specific fundamentals. But there many factors which come under Industry specific fundamentals and Economy specific fundamentals and also insider information like merger & acquisition, Bonus issue, right issue, dividend declare, management restructuring etc. play huge role in determining stock prices which are not considered in models. So models only give the expected value and help to take investment decision accordingly.
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Dr.Sharama, Anil.K. Kumar,Satish., (2010) ―Economic Value Added- Literature Review and Relevant Issues‖,International Journal of Economic and Finance, Vol.2, Page-2-3.,www.ccsenet.org/ijef. Kumar, SSS.,(2003), ―Some Refinements to The Stock valuation Models Based on Accounting Variables‖ , South Asian Journal of Management, Vol.10.,No.2, Page 1-3.
Mishra, P.K., Das, K.B., Pradhan, B.B., ― Empirical Evidence on Indian Stock Market Efficiency in context of the Global Financial Crisis‖, Global Journal of Finance and Management,Vol.1.,No.2, Page 1-10.,http://www.ripublication.com/gjfm.htm. Chandra, Prasanna., ―Investment Analysis and Portfolio Management‖, CFMMcgraw-Hill Professional series in Finance, Third Edition. ―Corporate Scorecard‖ Capital Market, Issue February 07, 2011.
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