What Is Dell Really Worth?

While students often expect that stock price valuation should result in an exact price that everyone agrees with, this almost never happens in practice. Take the court case involving Dell's management buyout (MBO). When the MBO went through in 2103, the price calculated by management experts, through a year-long process, was $13.78 per share. However, a group of dissident shareholders had independent experts value Dell at $28.61 per share, a difference of $28 billion. In the valuation, both parties used the same components: the forecast cash flows for a specific period, the value of the cash flows beyond that period, and the discount rate (WACC). However, the experts differed on the company's capital structure, as well as the cost on equity. In the end, the court used its own assumptions and arrived at a share price of $17.62 per share. As you can see from Dell, experts can use the same technique and arrive at widely differing answers when valuing a company.

Dow 150,000!

With the DJIA at about 18,500, it may be hard to imagine the DJIA hitting 150,000, yet there is a good chance the Dow hitting or exceeding that mark in your lifetime. Even though the number may seem impossible, such is the power of compounding. As this article points out, for the Dow to hit 150,000 by 2046, the annualized return only needs to be about 7.25 percent. One important note on the Dow is that it is a price index, not a total return index, so it excludes dividends. Unfortunately, many people, including business writers, have little idea of the effect of compounding. In 1995, when mutual fund pioneer Bill Berger predicted that the Dow would hit 116,200 by 2040, the business writer audience laughed. However, based on the level of the Dow when he made the prediction, such a move only required an annual return of about 7.5 percent. While we hope you take many things from this textbook, time value of money and compounding is perhaps the most important. 

A Critical Examination Of Earnings

A recent article made us think about the importance of definitions. The article states: "After all, in the long-run stocks are fundamentally driven by earnings and expectations for earnings growth." While we agree in part with this statement, we bet most people reading the article automatically think of earnings as net income and EPS. In reality, "earnings" is often used loosely to relate more to cash flow, which is a more important driver of stock price than accounting earnings. Remember, accounting numbers can be distorted much more easily than cash flow. There is another factor that is equally, if not more important, that is the required return. In increase in the required return on the market or a stock can often have a large impact on stock prices.

Delta Loses Big On Fuel Hedge

Companies with significant risks, such as currency or commodity risks, often hedge exposure to that risk. An industry with a a history of hedging is the airline industry, with companies often hedging fuel prices. However, not all hedges make money. For example, Delta Airlines recently announced that it lost $450 million on its fuel hedges in the second quarter of 2016 as it closed all of its hedges for the year. Delta is not alone as other airlines such as U.S. Airways and United have abandoned fuel hedges, citing lower fuel prices. We would like to point at that lower prices are not a good reason to eliminate hedges. By eliminating its hedges, Delta is now subject to the risk of increasing fuel costs. A hedge is designed to reduce volatility, so a reason to not hedge is the lack of volatility, not low prices, a fact often missed. Looking at the quote in the article from CNN Money: “Fuel prices are up 60% from their January lows, but they’re down 20% from a year ago. So, even with the cost of canceling its fuel contract, Delta will save money on fuel … in the second quarter.” While we agree that Delta will make more money with lower fuel prices compared to January, if fuel prices increase, Delta will not make as much as they could have going forward.

You Can't Keep A Good Twinkie Down

In 2013, facing imminent bankruptcy, Hostess, the maker of the iconic Twinkie, was sold for $410 million. Since then, the company has been turned around and a deal was recently announced that values the company at about $2.3 billion. Private equity group Gores Group bought Hostess and will take the company public. So, while you have been able to eat Twinkies, you will soon be able to invest in them again.

SunEdison Bankruptcy

In April 2016, solar energy company SunEdison filed for Chapter 11 bankruptcy.  Yesterday, the company won court approval for a $1.3 billion operating loan, but in an indication of the contentious nature of the bankruptcy, part of the loan is designated to fund a creditor probe into the company's activities, particularly in November. During that time, the company reconstituted the boards of two yieldcos, fired the conflicts committees of those yieldcos, and named Sun Edison's own CFO as the CEO of both yieldcos. A shareholder lawsuit in the bankruptcy argues, in part, that the corporate governance was insufficient as conflicts committees were reformed when the yieldcos would not prepay for solar projects that were being developed in India.

PE Ratio Math

As we mentioned in the textbook, when you are examining ratios, it is important to not only learn if a ratio has changed, but why it has changed. A recent article about the PE ratio highlights our discussion. Most people believe that an increasing PE is due to an increasing stock price, but as with any fraction, a change can also occur due to a change in the denominator. Currently, the PE ratio of the S&P 500 is about 19, above the 5-year and 10-year averages of about 16. As a result, many market analysts are predicting a declining stock market. However, even with a falling PE ratio, stock prices can still increase as long as earnings per share increase at a faster rate than stock prices. While we are not predicting the stock market, the article does note there are many periods in stock market history that earnings growth exceeded stock price growth, PE multiples declined, yet the bull market continued.