Question

Given the following information on US Tobacco, determine whether the company’s stock is attractively

priced based on the two valuation methods (DVM, P/E).

US Tobacco S&P 500

Recent price $27.00    $ 290

Anticipated next year’s dividend $1.20    $ 8.75

Growth in dividends & earnings 10.0%    7.0%

Required return 13.0%

Estimated next year’s EPS $2.40 $16.50

P/E ratio based on next year’s earnings 11.3 17.6

Dividend Yield 4.4% 3.0%

Answer 1

Dividend Valuation Method

The stock price with the use of dividend valuation method is arrived as below:

Stock Price = Dividend Next Year*(1+Growth Rate)/(Required Return - Growth Rate)

Substituting values in the above formula, we get,

Stock Price = 1.20*(1+10%)/(13% - 10%) = $44

_____

P/E

The stock price with the use of P/E is derived as follows:

P/E = Market Price Per Share/Earnings Per Share

Substituting values in the above formula, we get,

11.3 = Market Price Per Share/2.40

Rearranging values, we get,

Market Price Per Share (Stock Price) = $27.12

_____

Conclusion

Based on the above calculations, it can be concluded that the stock is attractively priced at $27 if we compare it to the stock price of $44 arrived with the use of dividend valuation method. On the other hand, when we compare the stock price of $27.12 arrived with the use of P/E method, the current stock price of $27 doesn't seem to be too attractive.