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Financial Market and Investment Analysis

Introduction

            AIREA PLC is one of the reputed design led specialist companies that believes in innovation. The company offers high quality original products and responsive customer service into both contact and retail market. The company operates on the philosophy of "to be black and white" and this shows transparency of the company in everything it does. This is one of the reason that enables the company to maintain consistency in its performance (AIREA, 2014). 

Figure 1: Comparison between share price of AIREA PLC and FTAS

            Talking about the company's performance in the last one year, the organization has performed well in the last quarter of the previous year and first quarter of the present year. However, as seen from the chart above, the second quarter of 2014 was not good for the firm as its price of its shares falls drastically in comparison to the FTAS index. Analysts believe that the main reason behind this is the entry of new competitors in the market. The company reacted well to this and formulated better strategies that helped it to again improve its performance (AIREA, 2014).

This essay is an example of a student's work

Disclaimer

This essay has been submitted to us by a student in order to help you with your studies. This is not an example of the work written by our professional essay writers.

A. Market Model

After applying regression analysis on the data collected from yahoo finance, following results are obtained:

Table 1: Regression Result

SUMMARY OUTPUT

Regression Statistics

Multiple R

0.059466

R Square

0.003536

Adjusted R Square

-0.01639

Standard Error

0.056124

Observations

52

 

Table 2: ANOVA Result

ANOVA

 

df

SS

MS

F

Significance F

Regression

1

0.000559

0.000559

0.177436

0.675391

Residual

50

0.157496

0.00315

Total

51

0.158055

 

 

 

 

Table 3: p value

Coefficients

Standard Error

t Stat

P-value

Lower 95%

Upper 95%

Lower 95.0%

Upper 95.0%

Intercept

-0.00269

0.007789

-0.34592

0.730856

-0.01834

0.01295

-0.01834

0.01295

RTNFTAS

0.238602

0.566438

0.421232

0.675391

-0.89912

1.376326

-0.89912

1.376326

 

Figure 2: Regression Plot between AIREA PLC and FTAS

Interpretation of Regression Analysis

            The coefficient of regression, that is, R2 is coming 0.003536, this show there is very weak or poor relation between the returns of AIREA Plc and returns of FTAS. Further, the value of F Significance is coming out to be 0.68. Theoretically, if the value of F significance is less than 0.05; it means at 98 per cent significance level, the model is valid. However, in this case, since the value of F significance is 0.68 and is coming out to be much higher than the value of F significance, showing that the entire model is not valid at 95 per cent significance level. Finally, the coefficient of RTNFTAS, that is, beta is 0.24 with p value more than 0.05, so the null is accepted coefficient and beta is rejected with a confidence > 95 % (Brigham and Ehrhardth, 2007). Thus the final regression equation comes to be:

y = 0.2386x - 0.0027

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B.1: The Yield Curve

            The yield curve is a kind of graph that shows the relationship between time and yield. The time is plotted on the x axis and the yield is plotted on the y axis. In other words, it can be said that yield curve plots relationship between maturity and yield. One can make best out of yield curve when the same type of bond is plotted for different maturity dates. This means the maturity date brings the major difference in the security. The yield curve can be used for plotting maturities for the corresponding yields such as municipal bonds, corporate bonds, treasure bonds, etc. By plotting the yield of similar bonds with different maturities, one can make comparisons between them by graphing how yield changes with the lengthening of maturity date. Basically, there are five kinds of yield curve (McKinney, 2004). A normal yield curve is upward sloping which means if all else parameters remain equal, that bond will pay a higher yield whose maturity date in longer in comparison to short maturity date bonds. After the great depression of 2008, the yield curve has remained upward sloping for the most of the times. Most of the institutions and individuals generally prefer lending money for the short term instead of longer period, as with the increase in time, the risk of paying money by the borrower become high. In other words, it can be said, longer is the term of the bond or loan greater is the risk of something unexpected. To compensate this risk, lenders generally demand a higher interest rate. If there are chances of a rise in interest rate in the future, investors will demand a higher rate of return for the long term bonds and if the long term bonds do not pay high, investors will buy short term bonds (Zietlow, 1998). Thus the demand of money will increase by putting pressure on interest rates. Irrespective of maturity, if the yield of bonds remains same, in that case a flat yield curve is obtained. A humped yield curve results if the long and short term maturity bonds have similar term rates in comparison to medium term rates. Finally, if short term bonds yield higher maturity in comparison to long term, the yield curved obtained is an inverted yield curve.

B.2: The UK equity market risk premium

            The equity risk premium is the difference value between equity market returns and the return offered by risk free assets such as treasure bills and government bonds. It is called as risk premium because it tells about the added compensation that an investor needs to hold among the two assets. If everything else is kept constant the change in equity risk premium will have a direct impact on the prices of stock. If there is a fall in equity risk premium, in that case the prices of the stock will rise. On the other hand, if there is a rise in equity risk premium, in that case, the prices of the stock will fall (Bhat, 2008). In other words, it can be said that a lower equity risk premium means higher prices and high risk premium results in lower stock prices. Three of the most popular approaches for determining equity risk premium are historical risk premium, implied risk premium and surveys. In historical risk premium the value of equity risk premium varies according to the method used. It is recommended that in this one must estimate the risk premium using 40 years data so as to minimize the standard error (Carroll, 2007). In case of survey approach, the value of equity risk premium depends on the hope of those interviewed and is therefore not a good indicator. Moreover, in this more emphasis is given on past than future. The best approach to determine equity risk premium us implied risk premium. In this, equity risk premium is determined on the basis of expected future cash flows. Standard error in case of implied risk premium is lower in comparison to historical risk premium.

Figure 3: Yield Curve

(Source: YieldCurve.com)

            In case of UK market, the average long term expected equity returns are approx 5.9% showing an arithmetic risk premium over TB of approx 3.21%. Moreover, the risk premium over gilt is 3.09%. Unlike the US, there are no issues with share buyback in the UK. Thus, the country needs to focus on dividend growth rather than earnings growth (Gregory, 2007).

C. Valuation Techniques

Below are the various financial figures of the company:

Profit after tax = 0.30 million GBP

Number of outstanding shares = 46.24 million

Equity share capital = 12.07 million GBP

Reserves = 0.43 million GBP

Price to book value = 0.45

PE ratio = 16.16

β = 0.24

Yield curve for UK t bill = 3.21%

Present Equity market return = 12.10%

Equity risk premium is assumed to be (12.10 - 3.21) = 8.89%

Presently the shares of AIREA PLC are trading at 11.89p

Earning based Valuation Method

Asset based Valuation Method

Dividend Valuation Method (constant dividend)

D. Buy, Sell or Hold

            There are four parameters that investors must use to break down the value of the stock in which he or she wants to invest. Following are the four parameters:

The Price to Book Ratio (P/B)

            At the time of torn up of a company, price to book ratio is used by the people to determine the value of the company. In the mature industry, there are several companies whose growth become flat with time; still those stocks can be good options for investment because of their assets. The book value includes land, building, equipments or any asset that can be sold in the market. It also includes bonds and stock holdings. Those firms which purely operate as financial firms, their book value vary with fluctuation in the market as these stocks consist of assets that which fluctuate in value. The book value of industrial companies is based on their physical assets which, as per the accounting rule gets depreciate with every passing year (McKinney, 2004). In both of the cases, a low P/B ration is beneficial for the companies. Thus, investors must focus more on actual assets of the company.

Price to Earnings Ratio (P/E)

            Among all the ratios, price to earnings ratio is the most scrutinized. In case of sizzle due to sudden increase in the stock price, the price to earnings ratio acts as steak. Even if there is no significant increase in the earnings of a stock, it can shoot up. So, if the earnings will not be there to back up the price, there are higher chances that the stock will fall back down. Through P/E ratio investors can determine how long the stock will take to pay back the investment if the external environment does not change much (Zietlow, 1998). Companies tend to maintain a higher P/E ratio so that it can attract more investors to enjoy larger earnings.

The Price to Earnings Growth Ratio (PEG)

            Another important parameter for valuing a stock is PEG. This ratio makes use of the firm's earnings and its historical growth rate. In addition to this, this ratio is used by the investors to compare one stock with another. Theoretically, a lower PEG ratio is assumed to be good for the investor as it reflects better future estimated earnings (Panday, 2009). By comparing two stocks, one can determine the cost investors are paying for growth in different assets. This technique is purely speculative as growth of stock cannot be guaranteed.

The Dividend Yield

            Dividend paying stocks attract investors the most as even in the gloomy situation they will get a paycheck. Thus, for companies, it is beneficial to have something as a backup at the time the stock flatters. Dividend yield tells about the amount of payday an investor can get against the investment. Dividend yield is determined by dividing the stock's annual dividend by its price (Carroll, 2007). It can be thought of as interest on the investment with an additional chance of growth.

            In the present case, after applying the three stock valuation techniques, it is seen that there is not much difference between the existing market price of the stock and the value determined through the stock valuation techniques. This means the stock is neither overvalues nor undervalued. In case of overvalued stock, it is suggested to sell the asset, whereas in case of undervalued stock, it is suggested to hold the stock. However, in the present case, neither of the situations exist, thus it is recommended to hold the stock at present. Finally, although there is no one method that is applicable to all the situations, still for the given company, the asset based valuation model is apt as this method finds the intrinsic or true value of the investment as it considers the fundamentals of a stock.   

This essay is an example of a student's work

Disclaimer

This essay has been submitted to us by a student in order to help you with your studies. This is not an example of the work written by our professional essay writers.

References

AIREA. 2014. [Online]. Available through: < http://www.aireaplc.com/ > [Accessed on 18th December, 2014].

Bhat, S. 2008. Financial Management. Excel Books India.

Brigham, E. and Ehrhardth, M. 2007. Financial Management: Theory & Practice. Cengage Learning.

Carroll, V. N. 2007. Financial Management for Pharmacists: A Decision-making Approach. Lippincott Williams & Wilkins.

Gregory, A. 2007. How Low is the UK Equity Risk Premium?. [pdf]. Available through: < https://ore.exeter.ac.uk/repository/bitstream/handle/10036/22094/0709.pdf?sequence=1> [Accessed on 17th December, 2014].

McKinney, B. J. 2004. Effective Financial Management in Public and Nonprofit Agencies. Greenwood Publishing Group.

Panday, M. I. 2009. Financial Management. Vikas Publishing House Pvt Ltd.

Yahoo Finance. 2014. [Online]. Available through: < https://uk.finance.yahoo.com/ > [Accessed on 17th December, 2014].

YieldCurve.com. 2014. [Online]. Available through: < http://yieldcurve.com/marketyieldcurve.asp > [Accessed on 18th December, 2014].

Zietlow, J. 1998. Financial Management for Nonprofit Organizations. John Wiley & Sons.

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