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Research and Analysis Paper 3: As a new junior analyst for your firm, your first assignment is to research, analyze, and value Johnson & Johnson stock (NYSE listed). Your boss recommends determining prices based on both the discounted cash flow method and comparable P/E ratio method. You are concerned about your boss’s recommendation because your Corporate Finance professor explained that these two valuation methods can result in widely differing estimates when using real data. You are hoping the two methods will reach similar prices. Good luck with that!
Your assignment is:
- Find and download the Johnson & Johnson 2019 Annual Report including Form 10-K for fiscal year ending December 29, 2019.
- Go to Reuters (http://www.reuters.com) and enter the symbol for Johnson & Johnson (JNJ) in the search box at the top of the web page (select Johnson & Johnson JNJ). From the Reuters website collect the following information (you should be able to find this in the free sections) and enter it into an Excel spreadsheet:
- The current stock price (last trade – upper left of page)
- The EPS (TTM)
- The number of shares outstanding
- The Industry PE Ratio (TTM) – you may need to look elsewhere for this.
- From the Key Metrics tab scroll down to find the Revenue Growth Rate (5Y), enter the number in your spreadsheet.
- Go to Morningstar (http://www.morningstar.com) and enter “JNJ” into the “Search Quotes and Site” box. Select Johnson & Johnson under the U.S. Securities section. Under “Financials” click Income Statement. Copy and paste (or use “Export to Excel to create anew file) the most recent three years (2017-2019) of income statements into a new worksheet in your existing Excel file. Repeat this for the balance sheets and the cash flow statements for Johnson & Johnson. Keep (or copy) all the different financial statement data in the same Excel worksheet NOTE: Make sure you are collecting the Annual data, NOT the Quarterly data.
- To determine the stock value using the discounted cash flow method:
- Forecast the free cash flows. Start by using the historical data from the financial statements downloaded from Morningstar to compute the three-year average of the following ratios:
- EBIT/Sales
- Tax Rate (income tax expense/income before sales)
- Property, plant & equipment/Sales
- Depreciation/property, plant & equipment
- Net working capital/sales
- Create an empty timeline for the next five years
- Forecast future sales based on the most recent year’s total revenue growing at the LT growth rate (5Y average) from Reuters for the first five years of the forecast.
- Use the average ratios from step 5. a. above to forecast EBIT, property plant & equipment, depreciation, and net working capital for the next five years.
- Forecast the the free cash flow for the next five years using Eq. 10.2 from the text (Section 10.1 in text).
- Determine the horizon enterprise value for year 5 using Eq. 10.6 and a long-term growth rate of 4% and a cost of capital of 11% for JNJ.
- Determine the enterprise value of the firm as the present value of the free cash flows.
- Determine the stock price using Eq. 10.4. Note: your enterprise value is in thousands of dollars and the number of shares outstanding Is in billions.
- Forecast the free cash flows. Start by using the historical data from the financial statements downloaded from Morningstar to compute the three-year average of the following ratios:
- To calculate an estimate of the JNJ price based on a comparable P/E Ratio, multiply the industry average P/E ratio by JNJ EPS.
- Compare the stock values from both methods to the actual stock price.
Submit a two-page double spaced paper summarizing for your boss your analysis and valuation with a few brief summary exhibits explaining how your analysis and outlook are quantified in your valuation model. Would you recommend investing in the company? Why or why not?
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