Valuation analysis

FORD MOTOR CO. STOCK VALUATION
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All successful organizations owe part of their achievement to the presence of their shareholders. It is thus due to this reason that firms have a duty of care to ensure that shareholders’ value is increasing and they take part in sharing the improved performance of the organization. According to Farnandez (2007, 2), the creation of shareholders value occurs when long-term returns exceed the cost of capital. Depending on the market reception of the stock, the stock price can be undervalued or overvalued accordingly. It is, therefore, the focus of all businesses that through the creation of value, the stock price will follow suit leading to the creation of wealth (Shah, 2015, 4). It is essential that while businesses can meet the short-term needs of the stakeholders such as payment of dividends and wealth appreciation, they should also be able to sustain maximum shareholders value in the long run through employment of capital budgeting techniques, ensure accountability, corporate ethics, and proper corporate governance (Shah, 2015, 2). Ford Motor Co. is aware of this fact and as such has endeavored to constantly deliver quality and value improvement in the subsequent financial year with the stock trading at $12.43 by the close of business on January 1, 2016. Through stock valuation of a firm, investors can know if the business is a good investment option or not. Valuation is also important for financial reporting and planning (Chu, Chen, & Chiou, 2014, 15).

A number of appraisal techniques can be applied in valuing Ford’s stock which include Economic Value Added (EVA), Total Shareholder Return (TSR), and discounted cash flows. The diagram below shows Ford Motor valuation for the past five years.
Figure 1: Ford Motors valuation
Economic value added (EVA)
EVA is based on the concept of economic profit maximization. It is, therefore, the difference between revenues and economic costs (book costs +opportunity costs). EVA adjusts capital and income to the computation of residual income (Shil, 2009, 169). The economic profit will thus be higher than normal costs in order for there to be an economic profit.
EVA= NOPAT-C*WACC where
NOPAT-Net Operating Profit after Tax,
C- Long term capital,
WACC- Weighted Average Cost of Capital.
The NOPAT = EBIT (1-t)
C= Fixed Assets + Net working capital (current assets- short-term liabilities)
Below is the working of EVA for Ford Motor for the past five years since 2011.
2011 2012 2013 2014 2015
EBIT 20213 5665 7155 1231 7373
NOPAT 15159.8 4248.75 5366.25 923.25 5529.75
C 206928 218346 215017 219366 243828
WACC 4.27 3.94 5.23 4.62 2.79
EVA -(868,423) -(856,034) -(1,119,173) -(1,012,548) -(674,750)
The EVA for Ford Company has been negative in the past five years. This indicates that the firm return on shareholder investment is poor. The company is hence viewed as either not generating any value or the value generated s relatively lower in comparison to the capital invested. According to Rago (2008, 9), EVA measures the growth cost the company has made concerning capital outlay. The negative EVA has however improved with 2015 reporting the least amount in the past 5years at -674,750. This shows that although the performance appears to be poor, it has however been improving and that is something shareholders would be interested in when deciding whether to invest in the business. Another reason for the negative result could be inefficiency in the use of capital by the firm. Since EVA measures the cost of capital, it can be relied upon by the company to improve it overall monetary performance at the minimal cost of capital (Rago, 2008, 16). Ford company like most organizations in the U.S use EVA to improve their profits and operations with owners’ interests in mind.
Application of EVA as a valuation tool in the firm is important when the company wants to motivate its management to perform better by using it as the basis of giving bonus instead of the ROA (Fernández, 2007, 54). Unlike the ROA, EVA ensures the most productive projects with highest returns and lowest initial outlay are undertaken to save the company regarding cost and increasing the wealth of shareholders through value creation (Rago, 2008, 7). According to Rago (2008, 18), an increase in company’s debt needs to be justified by an increase in profits attributable to it hence. This can only be achieved if managers have a share in the success. EVA is a more superior evaluation method when compared to P/E.
TSR measures return on investments over a given period including dividends payable. It is most appropriate for long-term evaluation of the value the company has created for the shareholder given the existing competitive market. According to Burgman and Van Clieaf (2012, 4), TSR measures the changes in future cash flows that shareholders will earn from their current investments. It, therefore, highlights any change in the economic status. The chart below shows shareholders’ returns change for Ford Motors in 2016.
Figure 2: Ford Motors TSR since 2011-2016
From the diagram, Ford’s TSR has been increasing steadily from 2011 to 2015 where it dropped by 22% to $125. The change is, however, higher than that of General Motors which stands at 12.5% at the beginning of 2016 as shown in figure 3 below.

Figure 3: General Motors TSR since 2011-2016
Net asset valuation
To evaluate the net worth of Ford Motor Co.’s shares, the price-earnings ratio (P/E) is derived from the past number of years and a comparison done. A cross-sectional analysis with the General Motors will show how the company has been performing in terms of asset valuation as compared to similar firms in the industry.
NAV= (assets-liabilities)* number of outstanding shares
P/E ratio
The P/E ratio estimates how much investors would be required to invest in order to earn a dollar from a company.
Price/ Earnings (P/E) = Market value /Earnings per Share (EPS).
P/E Ford Motor 2013 2014 2015
Market value 17.24 17.24 15.01
EPS 1.76 1.86 1.86
P/E(Market value/EPS) 9.8 9.27 8.07
The P/E ratio of Ford Co. has been declining over the past three years as shown in the computations above. The decline shows a drop in the value of the firm’s share in comparison to prior years. The ratio shows that the market is willing to offer lesser to purchase a share of the company in consecutive years. For instance, in 2015, investors would be willing to part with $8.07 than $ 9.27 and $9.80 they would have paid for the same dollar earning in 2014 and 2013 respectively. This is a worrying trend and could be considered to imply that the company future growth and performance will be lower hence lower earnings. Investors would be skeptical of investing in such stock at the moment until they can be sure of improvements in the same (Ulbrich, 2013, 3). For Ford Company this is a threat to their ability to grow their capital pull in terms of shareholders investments. It waters down their efforts in wealth creation and value improvement for their shareholders. According to Wang (2014, 4), it is however important to note that the declining P/E does not necessarily indicate poor performance by the firm as the market value of a stock may fall due to external industry factors that are beyond the control or influence of the company such as change in market seasons, governmental policies and regulations, and change in consumption patterns. For example, depression in the economy affects the market prices of stock in general.
From the analysis, Ford’s EPS has increased from 1.76 to 1.86 from 2013 to 2014 remaining constant in 2015 despite the fall in market price. It thus means that the firm has continued to create value for shareholders and hence good performance. In order to get a true picture of Ford’s P/E and its implications there on, a cross-sectional analysis is used.
The following is the P/E results of General Motors, an American based motor company exposed to the same industry factors.
General Motors 2013 2014 2015
M value 27.5 33.69 39.6
EPS 3.18 3.05 5.02
P/E 8.65 11.05 7.89
P/E ratio of General Motors from the workings have been fluctuating in the past three years possibly caused by the changes in the economy. There was a rise of $2.4 in 2014 and a decline of $3.16 in 2015. When compared to GM, Ford’s future performance and earnings can be easily estimated. It is only in 2014 that GM’s P/E was higher than that of Ford by $1.78. Ford’s stock hence are more valuable than that of GM. It is, however, notable that the market price and the EPS for GM are relatively higher in the three years when compared to that of Ford. GM market value has increased by $6.19 and $5.91 in 2014 and 2015 respectively. This is in contrary to that of Ford which has been declining. The implication of this is that GM’s stocks are more valuable in the market than those of Ford despite a better P/E ratio.
From the two valuation methods, the P/E ratio is positive while the EVA is negative. This is possible according to the Chu, Chen, and Chiou (2016, 8), who point out that overvaluing and undervaluing of a firm’s stock often affects the EPS. The figure 4 below shows the comparison in market value between Ford Motors and General Motors.

Figure 4: GM and Ford Motors market value
Discounted free Cash flows
Estimation of free cash flows is used in the valuation of firms in the same industry with similar cost structures (Drake, 2005, 2). A look at Ford’s operating,
Ford’s operating free cash flows to equity (FCFE)
FCFE= Cash flows from operations – capital expenditure + net borrowing
Net borrowing = net debt – debt repayment
2011 2012 2013 2014 2015
Net debt 82,060 85,927 98,437 105,532 118,952
Debt repayment 17,155 18,299 15,556 12,941 11,511
Net borrowing 64,905 67,628 82,901 92,591 107,441
FCFE is;
LINK Excel.Sheet.12 “Book1” “Sheet1!R2C2:R7C7” a f 4 h * MERGEFORMAT
FCF to equity ($’000′) 2011 2012 2013 2014 2015
Cash flows(operating activities) 9,784 9,045 10,444 14,507 16,170
Capital expenditure 4,293 5,488 6,597 7,463 7,196
Net borrowing (net debt-debt repayment) 64,905 67,628 82,901 92,591 107,441
FCFE (cash flow-capital expenditure +net borrowing) 70,396 71,185 86,748 99,635 116,415
LINK Excel.Sheet.12 “Book1” “Sheet1!R2C2:R7C6” a f 4 h * MERGEFORMAT
The FCFE of the firm has had an upward trend which means the value of the stock is increasing.
Free cash flows to the firm thus is
FCFF= Cash flows from operations + (Interest (1-tax) – capital expenditure).
LINK Excel.Sheet.12 “Book1” “Sheet1!R2C2:R7C7” a f 4 h * MERGEFORMAT
FCF to equity ($’000′) 2011 2012 2013 2014 2015
Cf operating activities 9,784 9,045 10,444 14,507 16,170
Interest(1-tax) .25(1-.40) 0.15 0.15 0.15 0.15 0.15
Capital expenditure 4,293 5,488 6,997 7,463 7,196
FCFE= cf +(interest(1-tax))- capital expenditure) 5,491 3,557 3,447 7,044 8,974

In the two years that is 2014 and 2015, the firm’s FCFF has risen contrary to the decrease in 2011, 2012, and 2013. It thus shows that Ford’s valuation has gone up. The rate of return appears to be different than that of the overall shareholders which implies that the firm ought to raise their production capacity to accommodate growth. The differences in the two methods are due to the fact that the weighted average cost of capital value is different for the two methods (Beisland, 2014, 127). Eliminating the difference will require estimation of the cost of capital under the same value.
According to Janas (2013, 24), the choice of the valuation method largely depends on the purpose the firm intends to achieve such as the expansion of operations, increased in profits, the creation of shareholders wealth, the general growth of the firm. Ford Company is targeting improvement of shareholders wealth hence the most appropriate valuation method would be the economic value analysis and price earnings ratio. The firm has been having a positive P/E ratio although it has a negative EVA. This could be due to the fact that the organization’s debt has been increasing more than the profitability. It thus means that the firm is using a lot of capital to generate profits yet the returns are not matching up the invested interest. Ford’s free cash flows is increasing an indication that the firm’s performance is getting better, however, more need to be done regarding increasing owners’ earnings if the firm wants to be a market leader in the industry.
When compared to other firms in this case General Motors, the firm stock value is lower than that of its competitor. Despite the fact that both firms have experienced a significant decline in earnings in given years, investors are however willing to pay more to acquire a dollar of GM’s stock than they would for Ford.

Bibliography
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