Singapore’s largest (and aptly-named) telecommunications operator Singapore Telecommunications Limited (SGX: Z74) closed at S$4.22 per share yesterday. Investors wanting to buy Singtel’s shares today can easily know that they’d have to pay a price that’s around that figure. But, is Singtel really worth S$4.22 a share? Asked another way, is the value of Singtel on a per share basis really around the neighbourhood of S$4.20? The art of value Estimating the value of a company’s shares is a big aspect of investing and a share’s value should be a key deciding factor for investors when it comes to making an investing decision….
Singapore’s largest (and aptly-named) telecommunications operator Singapore Telecommunications Limited (SGX: Z74) closed at S$4.22 per share yesterday.
Investors wanting to buy Singtel’s shares today can easily know that they’d have to pay a price that’s around that figure. But, is Singtel really worth S$4.22 a share? Asked another way, is the value of Singtel on a per share basis really around the neighbourhood of S$4.20?
The art of value
Estimating the value of a company’s shares is a big aspect of investing and a share’s value should be a key deciding factor for investors when it comes to making an investing decision.
There are two main ways for investors to estimate the value of a company. One method works forward, in that an investor will try to estimate the growth rates that a company will achieve in important financial metrics like its earnings per share, dividends per share, or cash flow per share.
The other works backward, in that we can look at a company’s current price and work out how much growth the market’s expecting the firm to achieve. From that, we can determine if the market’s expectations are reasonable or ridiculous.
In this example, we’d be using a variant of a simple dividend discount model called the Gordon Growth Model to figure out the market’s expectation of Singtel’s future growth in dividends.
A dividend discount model is meant to value a company based on the total amount of dividends that the firm would distribute to shareholders from now till perpetuity; the Gordon Growth Model simply adds in a factor to account for a company’s future growth in dividends. The formula for the Gordon Growth Model is shown below:
Share Price = Expected Dividend Per Share One Year From Now / (Discount Rate – Dividend Growth Rate)
Singtel’s annual dividend for the fiscal year ended 31 March 2015 (FY2015) was S$0.175 per share, up 4.2% from the dividend of S$0.168 per share a year ago. Over its past five fiscal years since FY2010, Singtel has held its annual dividend stable for two fiscal years before raising the payout. Given that the telco had just increased its dividend, let’s assume, for the sake of this exercise, that the dividend for FY2016 would also be S$0.175.
As for the Discount Rate, the textbook method – which follows the Capital Asset Pricing Model (it’s perfectly acceptable to not follow the CAPM when trying to estimate the value of a stock, but I’d still use the model in here for the sake of completeness) – is to incorporate the risk-free rate as well as the beta of Singtel’s stock.
The risk-free rate is normally taken to be the 10-year government bond yield; currently, the yield on a 10-year Singapore government bond is 2.37% and so, that shall be our risk-free rate.
Meanwhile, the beta of any stock is simply a measure of a stock’s volatility in relation to a broad market index; in Singtel’s case, data taken from investing research outfit Morningstar has the beta figure pegged at 1.02.
With the explanations out of the way, here’s how the formula for the Discount Rate looks like:
Discount Rate = Risk Free Rate – Beta (Market Return – Risk Free Rate)
You’d notice that there’s one last variable in the Discount Rate formula which I have not discussed, and that is the Market Return. I’d do this now.
The Market Return is simply the long-term return of the stock market as a whole. In this exercise, I’d be using the long-run return of the SDPR STI ETF (SGX: ES3), an exchange-traded fund which tracks Singapore’s market barometer, the Straits Times Index (SGX: ^STI). Since its inception in April 2002, the SPDR STI ETF has generated a total return (inclusive of reinvested dividends) of 8.6%.
So, when we input all the relevant figures into the Discount Rate formula, we’d end up with a Discount Rate of 8.7% for Singtel.
The next thing we have to do now is to punch all the numbers we have obtained so far into the Gordon Growth Model. This is what we’d end up with:
4.22 = 0.175 / (0.087 – Dividend Growth Rate)
As you can see, the only variable now that’s now unknown in the Gordon Growth Model is Singel’s future growth in dividends. After some basic arithmetic, we thus arrive at the conclusion that the market expects Singtel to be able to grow its dividends at an average pace of 4.55% per year over the long-term future.
So what’s the value?
We can then use the expected growth rate of 4.55% and compare it against our own assessment of what Singtel may be able to achieve.
So, based on all the above assumptions, if you expect Singtel to be able to grow its dividends at a faster clip than 4.55% annually, the giant telco will be undervalued at S$4.22. But, if you’re not confident at all about Singtel’s growth and think that its future dividends will step up at a much slower pace, S$4.22 might be too high a price to pay.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim doesn't own shares in any companies mentioned.