stock-qbe-price

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Subject Area - Finance Stock QBE Price Stock evaluation of QBE This essay evaluates the financial performance of QBE’s share and if its shares are over or under valued. The following analysis considers discount rate, linkage between price and earnings, effect of growth rates on the share price, measurement of risk of the company and the influence of share on a portfolio. Financial performance of QBE QBE Insurance Group Limited is one of the largest listed insurance companies in Australia. It is a well-managed historical Australian general issuer and has delivered good and steady growths both in its operation and earnings in the past few years (QBE 2008).For the half year ended 30 June 2008, it is highlighted in its financial report that QBE has a pleasing profitability achievement compared to the past year (Appendix 1). QBE (2008) (Appendix 1) reported that insurance profit had increased by 6% to $ 1116 million in its income statement. The figure amounting to $920 million indicated a 7% increase in the profit after tax before capital losses on equities, but this figure was down to $859 million, representing a 7% decline from 2007 after the capital losses were included. In the Balance sheet, total assets had a slightly decrease to $39144 million for this half year while total liabilities was reduced significantly by $800 million to $30270 million. 61 cents of interim dividend will be paid in September, which creates a highest record in the company’s history. Cash flow from operating activities had a dramatic increase from $785 to $839 dollar. Many key ratios such as combined operating ratio and the insurance profit margin indicated an achievement in strong insurance profitability. On the other hand, an increase in large inevitable risk and unavoidable claim is also presented (Appendix 2). Though the QBE’s financial report demonstrates sound development, relying on the financial statements only is not enough to give the investors an in-deep perspective about whether the company is worth investing in. Therefore, it is necessary to evaluate the company’s value and conduct a financial analysis by using basic financial techniques. The discount rate which should be used in your analysis A number of methods can be used to value companies and their stocks. One of theoretical models is dividend discount model. This model lies in the present value rule (Damodaran 2002). The discount rate in this model is known as the risk-adjusted rate or cost of equity capital at which future expected dividends discount, making the stock price equals to present value of those future dividends (Kolb & Rodrígez 1996). In order to choose a proper discount rate, some possible equations for estimation are considered as below 1. Weighted Average Cost of Capital

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The UK’s original provider of custom essays www.ukessays.com If you are using this resource in your work please remember to reference and cite the original work found here: http://www.ukessays.com/essays/finance/stock-qbe-price.php The company cost of capital is a weighted average of the returns demanded by the proportion of various types of obligations for the investorsdebt, preferred stocks, and common stocks that are issued to finance the company’s operations and investments (ValuePro n.d.). The formula for WACC is given as. From the company’s balance sheet in 2007 (Appendix 3), the debt was $31070 million and it can be computed that the value of common stocks was $7392 and preferred stocks were worth $1295 million, which made up of the total market value of QBE to $39613 million. The debt holders required a rate of return of 6.5 percent while the expected rate of return on the common and preferred stocks was 26.1 and 6.8 percent, respectively. Based on the date above and 24% corporate tax rate, WACC of QBE is calculated as 9.87%. 2. Capital asset pricing model CAMP is one of the commonly used models to measure the relationship between market risk and expected return. The expected return of a stock linearly relates to risk on security market line, as measured by beta (Kolb & Rodrígez 1996). The basic equations of CAPM is R = Rf + β( Rm - Rf ). From the historical record of Reserve Bank of Australia (2008)(Appendix 5), 90 Day Bank Accepted Bill rate is averaged at 7.36% for the past 12 months, which can be used as market risk-free rate. The 1 year expected return on S&P/ASX 200 Market portfolio is 16.74%, resulting in 8.71 % market risk premium. Given a beta of QBE estimated at 0.6749(Appendix 4), the excepted return on QBE is 13.24%. 3. Constant dividend growth model Under the constant growth assumption, the expected rate of return of a share can be calculated after rearranging the constant-growth formula (). Analysts assumed QBE would grow at about 5.8% in the next period (Appendix); the average price of the company for the past 12 months was $28.47. With such a growth rate, the company tends to pay a dividend of 129 cents at the end of 2008 in terms of 122 cents paid in 2007. Therefore, the expected rate of return is calculated as 10.33%. Since the equations and data are based on company actual information and the real market condition instead of assumptions, discount rate calculated by using WACC or CAPM is more preferable to be used in the analysis. Linkage between share price and earnings per share Find out how our expert essay writers can help you with your work... To see whether there is a link between share price and earnings per share, P/E ratio is widely used and it is a good valuation metric in today’s stock market. P/E ratio is simply the share price of a corporation divided by its earning per share. And it can be helpful to determine if the individual stocks are reasonably priced (Trading Critic 2006).

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The UK’s original provider of custom essays www.ukessays.com If you are using this resource in your work please remember to reference and cite the original work found here: http://www.ukessays.com/essays/finance/stock-qbe-price.php Taking QBE’s average price of $23.90 from the first eight months of 2008 and a approximate forecast of 231.5 cents earning per share at the end of 2008 (Appendix),then it can be calculated that QBE has the average P/E ratio10.3 during this period. The P/E ratio tells a investor the market perspective about a stock and looks at how stock price is related to the company’s earnings (Badami n.d.). Generally, P/E ratio is not often used solely and analysts prefer to compare the P/E ratios of similar comparable companies in order to ascertain the market value of the stock relative to another (Frino et al. 2004). In the following table, the comparison of P/E ratios for QBE and the Insurance Australia Group Limited (IAG) are presented: Table1 : P/E ratios for QBE and IAG, 2007-2008 QBE IAG EPS(cents) PRICE($) P/E ratios EPS(cents) PRICE($) P/E ratios 2007 217.3 25.82 10.7 36.1 4.15 11.5 Find more free essays like this one... We have a large reference library of essays that you can use as research materials to help with your own writing check out our free finance essays. Share this resource with your friends... We hope you found this information in this free pdf useful. Please spread the word and tell your friends how this information has helped you with your studies and feel free to share this pdf with others, so it can help them too.

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2008 229.9 23.90 10.4 8.0 4.18 52.2 (Source: InvestSMART 2008) Given that QBE and IAG are both largest insurance companies in Australia and both are listed in the top 200 stocks in ASX, a reasonable assumption that they are comparable can be made. From the table, it can be seen that although the P/E ratio was close in 2007 for these two companies, it has not been the case in 2008. Using historical EPS numbers, a comparison of the P/E ratios would indicate that one stock is relatively under-priced by the market while the investors were paying too much attention to another. In 2008, IAG has a P/E ratio five times that of QBE, indicating that IAG shares were relatively overpriced and QBE was relatively under priced by the market (Frino et al. 2004). In this case, QBE is a more attractive investment because lower P/E ratio means higher future earnings are expected compared with the recent annual earnings (Maranjian S 2007). However, a low P/E ratio does not always denote success since higher P/E ratio suggests that the investors think that the company has better growth opportunities (Brealey, Myers & Marcus, 2007). You can get expert help with your essays right now. Find out more... P/E does not mean everything. Despite a linkage between price and EPS, the earning of the company is not the only determining factor on share price’s performance. Therefore, other factors are usually considered before they make any investment decision. Different growth rates effects on the share price As can be seen in the dividend discount model, today’s stock price depends on the future dividends. Since growth rate closely relates to the dividend distributed, it often has impacts on the share price. In the following analysis, two extreme cases of the dividend model will be compared to see the effect of growth rates on QBE’s price: Zero-growth model Find more free essays like this one... We have a large reference library of essays that you can use as research materials to help with your own writing check out our free finance essays. Share this resource with your friends... We hope you found this information in this free pdf useful. Please spread the word and tell your friends how this information has helped you with your studies and feel free to share this pdf with others, so it can help them too.

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When a company pays out all the earning to the shareholders, it could not grow as it doesn’t have the ability to reinvest. Then dividend being paid is the same forever so that they are considered as perpetuity (Brealey, R, Myers, S & Marcus, A 2007). Assume QBE has no growth in its business in 2008; as a result, in the future it will have the same earning per shares 217.3 cents as 2007 and all of them are going to be paid as dividends. Using the WACC 8.46% as the discount rate, the curries stock price is worth $25.69. Constant-Growth Model In reality, it is not easy to estimate the future dividends for the every year. An assumption that dividends grow at a constant rate simplifies the dividend discount model and makes it more convenient to value the price of the stock (Frino et al. 2004). Base on the company operating and financial performance of QBE, analysts estimate a 5.8% growth in the dividends and assume that the investors expect this rate will be fixed each year in the long term. The expected dividend to be paid in the next period is expected to be 129 cents. Discounted at WACC 9.87%, the share price of QBE should be worth $32.94 today. From the above calculations, results from the two different models differ from each other. A higher growth rate in dividends will result in a higher stock price today. Given the present dividend and the discount rate are the same, the higher the expected dividend growth rate, the higher the current stock price. In other words, there is a direct relationship between price and growth. If the company has no growth in its earning or dividends, the price will remain the same forever. In contrast, since there is a steady rate in the growth, share price will be ascending constantly according to the future growing dividends. Measurement of the risk As the stock market is known to be one of the riskiest investment markets, analyzing risk is especially helpful for the investors and shareholders to find out an appropriate balance between risks and return (BNY Mellon, 2008). To see the degree of risk that QBE is subjected to, a measurement of risk can be evaluated based on some useful indicators. 1. Beta Beta is one of the most popular statistical measures of risk, which is the key component in constructing the CAMP (McClure 2008). It represents the incremental risk added in a given portfolio and it also measures volatility of the stock in relation to the reference index (Yahoo! UK Limited. 2008a). Compared to beta of ASX market and insurance sector (1.04 and 0.98 respectively), QBE currently has a beta of 0.6794, indicating a relatively low level of sensitivity of QBE’s share to the overall market and sector variations (Fernández Find more free essays like this one... We have a large reference library of essays that you can use as research materials to help with your own writing check out our free finance essays. Share this resource with your friends... We hope you found this information in this free pdf useful. Please spread the word and tell your friends how this information has helped you with your studies and feel free to share this pdf with others, so it can help them too.

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The UK’s original provider of custom essays www.ukessays.com If you are using this resource in your work please remember to reference and cite the original work found here: http://www.ukessays.com/essays/finance/stock-qbe-price.php 2002). A low beta not only suggests that the stock possesses a lower lever of risk but also a lower expected return. (McClure 2008) Find out how our expert essay writers can help you with your work... 2. Expected rate of return Using CAMP, the expected return on QBE is 13.24% while market return of S&P/ASX 200 is currently 16.07%. Although it is lower than the market return, a direct relationship between risk and return indicates that the risk accompanied with the high expected return can not be ignored and shareholders must be careful. 3. Standard deviation and Volatility A share’s volatility is usually a risk indicator for both the share’s market risk and diversifiable risk (Fernández 2002). On daily returns base, volatility is calculated by using standard deviations and it measures the stock variability in relate to the overall market (Yahoo! UK Limited. 2008b). If a share’s volatility is high, it implies that share’s future return may vary within a relatively broad range and vice versa (Fernández, P 2002). A relatively high Quarterly Volatility of 41.1075% indicates that a high varianation of the share price from the expect value is presented at the moment. 4. Other indices QBE has a negative 8.1277% relative performance and a positive 0.9994 relative strength, representing that the stock has a worse performance than that of the index this year, but it is good to see over time this has become less and less( Yahoo! UK Limited. 2008c). Non-market risk Some of risks are the firm-specific risks and they are diversifiable and can be reduced or eliminated, which is known as non-market risk (Damodaran 2002). QBE has the following risk categories: Acquisition risk, Operational risk, and Capital and regulatory risk. Although risk management has been established and administered in the company, nonmarket risk still exists in QBE’s operations since new risk often appears under different economic conditions and dealing with risk is a long-term task for the company (QBE 2008). There is no doubt that investors always like high expected return and low standard deviation or Volatility (Brealey, & Myers 2003).From the measurement of key indicators, QBE provides a relatively high expected rate of return while a high volatility is presented. This is not optimal. Therefore, a certain high level of risk is involved in QBE due to the factors of market and the company itself. Is the share over-valued or undervalued? Determining if a share is undervalued or overvalued often gives investors a positive judgment on the company as investors always want to find out the appropriate time to buy or sell the share. However, evaluating what the “right” value is for a share is always difficult (Schoen 2003).Generally, several indicators of the company can be useful tools for Find more free essays like this one... We have a large reference library of essays that you can use as research materials to help with your own writing check out our free finance essays. Share this resource with your friends... We hope you found this information in this free pdf useful. Please spread the word and tell your friends how this information has helped you with your studies and feel free to share this pdf with others, so it can help them too.

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The UK’s original provider of custom essays www.ukessays.com If you are using this resource in your work please remember to reference and cite the original work found here: http://www.ukessays.com/essays/finance/stock-qbe-price.php the stock valuation. You can get expert help with your essays right now. Find out more... 1. P/E ratio Since P/E ratio demonstrates how a company’s market price compares to its earnings per share, it becomes a popular and frequently used tool to see if the stock is over or under priced. From the previous analysis, P/E ratio is calculated as 10.4% and it has relatively under-priced relative to another insurance company IAG. It is also available to Compare QBE’s P/E ratio to those of the market and insurance sector(11.91 and 16.07 respectively) (Appendix), Based on these data, a low P/E ratio represents the company is undervalued. Comparing with 2. Intrinsic value V.S. market price From the dividend discount model, average share price of QBE is approximately calculated as $32.94 while in fact, the monthly average price is about $24.32. Many analysts perceive EPS growth rate as a much more relevant tool for determining whether a company is undervalued or overvalued. As the company grows at such a steady rate in the insurance industry, it can be concluded that the performance of share is under-priced. The current The figure below show the historical price performance compared with ASX 200 and insurance sector. As can be seen from the diagram, the price kept falling for the past few months. The price line was always under the sector and ASX line since January of 2008. A normally evaluated stock will move and fluctuate around the market. According to the operational strength and market share of the company, the price should have not perform It can be estimated that the stock is under performances due to some uncertain factors An undervalued stock is defined as a stock that is selling at a price significantly below what is assumed to be its intrinsic value (finance).The share of QBE has characteristic of low P/E ratio and under-pricing.A overall conclusion can be made on the QBE that its share is undervalued. What influence would you expect your share to have on the performance of a portfolio? It is known that constructing a portfolio is a good investment strategy to spread the risk of individual stocks since specific stock always has an influence on the overall performance of the portfolio due to its allocation, own risk and expected return (Forsythe 2008).In the following example, the impact of QBE’s share on a portfolio will be discussed. Find more free essays like this one... We have a large reference library of essays that you can use as research materials to help with your own writing check out our free finance essays. Share this resource with your friends... We hope you found this information in this free pdf useful. Please spread the word and tell your friends how this information has helped you with your studies and feel free to share this pdf with others, so it can help them too.

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The UK’s original provider of custom essays www.ukessays.com If you are using this resource in your work please remember to reference and cite the original work found here: http://www.ukessays.com/essays/finance/stock-qbe-price.php Suppose an investor has a stock portfolio comprising three different shares --Telecom Corporation of New Zealand Limited (TEL) and Woolworths Limited (WOW), Compared to QBE, TEL and WOW are two relatively less risky stocks because they have lower beta and lower Quarterly volatility than QBE. The table given below shows the relevant data of these three companies: To give an in-depth analysis to the investors, three scenarios in terms of the different proportion allocated on QBE in this portfolio are compared: Scenario1: QBE 90%, TEL 5%, WOW 5%. Assume the investor invested 90 percent of his funds in QBE and equally 5 percent in both TEL and WOW in the portfolio. (Scenario2 and 3 are in similar logic) In this case, the portfolio expected return is calculated as 13.03% and standard deviation is 37.07% Scenario2: QBE 50%, TEL 25%,WOW 25% Portfolio expected return is 12.18% and standard deviation is 23.46% Scenario3:QBE 10%, TEL 45%, WOW 45% Expected rate of return on the portfolio is 11.33% and standard deviation is 17.76%. The data from three scenarios are summarized by the following column and line graph: Figure 2: Weight of QBE, portfolio expected return and Quarterly Volatility The figure illustrates that there is a descending trend on the expected return and the standard deviation of the portfolio against the degressive levels on QBE’s weight. If a large percentage of QBE’s share is allocated, the overall portfolio has high expected return and high standard deviation, which is fairly close to the conditions of QBE. When QBE accounts for half of the total investment, the portfolio expected return declines to 12.18% and standard deviation drops dramatically by 36.71% to 23.46%. For the level of 10% weight of QBE’s share, the portfolio reaches the lowest level of expected return and standard deviation. It can be concluded that QBE plays a significant role on the performance of the overall portfolio while it takes up a large portion, making the portfolio become more risky. In contrast, this risk is substantially spread by the other two low-risk shares as QBE only occupies a small proportion in the portfolio. Under this circumstance, the small weight of QBE does not affect much on the portfolio and diversification lead to a success of elimination in risk (Fernández 2002) Conclusion: From the above analysis, it can be found that QBE has a outstanding performance in operation and it develops a steady growth potential during these few years. It provides a high expected return Moreover, P/E ratio and the intrinsic value of the share suggest that its price is under-valued. Find more free essays like this one... We have a large reference library of essays that you can use as research materials to help with your own writing check out our free finance essays. Share this resource with your friends... We hope you found this information in this free pdf useful. Please spread the word and tell your friends how this information has helped you with your studies and feel free to share this pdf with others, so it can help them too.

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Overall, it is worth to invest in QBE owing to a relatively good evaluation on the the company’s real value and development but risk involving the share must be awared and it can not be overlooked when making decisions. Recommendation: In the short run, although there is a price fluciation, For longer term investors, QBE is an excellent stock for inclusion in the portfolio since growth strategy of the company has deliver well and extensive risk management are implemented successfully (Yahoo! 2008). This essay was written by a student and then submitted to us to help other students. You should not hand in this essay as your own work - we do not condone plagiarism! If you need custom essay help, then check out our essay writing service.

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