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Alternative Valuation Models
Alternative Valuation Models
The purpose of this post is to analyze alternative valuation models that could be use to possible determine GAP Inc. stock price. The methods included: Residual Operating Income (ROPI) Model, Dividend Discount Model, and the Market Multiples Approach. All of these valuation methods will help to determine what the stock price of GAP Inc. is and if the stock has been overvalued or undervalued.
Residual Operating Income (ROPI) Model
Residual Operating Income (ROPI) Model
Key Assumptions
The ROPI model predicts the surplus profits a company will generate annually after fulfilling its obligations to investors and other stakeholders. This enables investors to gauge the potential stock price by evaluating the yearly excess income produced by the company. The first step was to get the Net Operating Assets from Our past completed post on Free Cash Flow. This number needed to be multiplied by our WACC which was right below 9% from our Free Cash Flow Valuation Model to determine our required NOPAT. Which I found surprising was the required NOPAT that was determined through the Net Operating Asset and WACC was much higher than the actual NOPAT that we calculated took off of the Free Cash Flow post leaving our residual operating income over the last 5 years to be in the negatives and a negative ROPI. We took the average ROPI for the last three years to be used. After determining the baseline ROPI we multiplied in by the growth rate for the next 10 years for GAP Inc. After determining the terminal value, we used the NPV or Net Present Value Function to determine the PV of Estimate ROPI which puts us at Figure 3. By taking this number and adding the Net Operating Assets as well as the Excess Cash/ Cash Equivalents we are able to determine the Firm Valyue. Firm Value consists of Debt and Equity so in order to find the Firm Equity Value we need to subtract the Value of Debt from the Firm Value. Taking the leftover Equity and dividing it by the number of shares we are able to get out estimation for our Value per Share. All of these steps are clearly seen in Figures 1-3.Analyzing the Final Stock Price
The final stock price that was estimated through the ROPI model was $23.53. This is only about $2 below what was determined from the Free Cash Flow MOdel. This model even being lower than the FCF model will still be included in the final stock price calucaltion because it is believed to have an accurate representation of the stock price for GAP Inc.
Figure 1: ROPI ROI CalculationsSource: S&P Capital IQ
Figure 2: ROPI Terminal Value CalculationsSource: S&P Capital IQ
Figure 3: ROPI Stock Price ValuationsSource: S&P Capital IQ and FactSet
Dividend Discount Model
Dividend Discount Model
Key Assumptions
The Dividend Discount Model is a simpler model that assumes that all extra profits for the firm are returned to shareholders in the form of dividends. This model calculated what GAP Inc. stock price was by discounting the value of its project dividend back to the present. Since the model is simpler, three are basic assumptions that are listed below.- Last year's dividend was found on GAP Inc. latest Value Line report as the sum of the dividends of the four fiscal quarters that made up the last fiscal year.'
- The growth rate in dividends was assumed to be the same as the growth rate as futures sales used in the Free Cash Flow and ROPI models.
- The required rate of return to discount the future dividend the WACC was calculated from the cost of capital.
Analyzing the Final Stock Price
The Dividend Discount Model had a very different final stock price compared to the FCF and the ROPI models. The stock price for April 30,2024 was $20.52. The estimated price from the DDM model was only $5.24 which is more than $15 dollars from the current value of the stock. This model had the largest gap from the rest of the alternative models making this one the outlier. I do not believe that this model works very well for GAP Inc. because they are not a mature firm and pay their investors very little dividend funds which give them room to grow. GAP Inc. invests a majority of its earnings back into the company to either make new products or to grow the overall size of the business.
Figure 4: GAP Inc. Dividend Discount ModelSource: S&P Capital IQ & Value Line
Market Multiples Approach
Market Multiples Approach
Choosing Competitors
The first major step when doing the Market Multiples approach is to determine which competitors you want to use to compare to GAP Inc. that are closest in size and other various financial calculations. I decided to keep the same competitors besides Burlington because they are much larger than GAP Inc. These companies were also recommended by FactSet Competition Tables, specifically the Apparel Retail. The companies that I choose were Abercrombie & Fitch, American Eagle and Urban Outfitters. (Figure 5)Calculations / Key Assumptions
The first step in completing the Market Multiples Approach was the company needed to have Value Line Reports to take from the Fiscal year 2023 that had specific measures including:- Sales per Share
- Cash Flow
- Earnings Per Share
- Book Value of Equity per share
- Price to Sales
- Market to Cash Flow
- Price Earnings (Trailing)
- Price to Book Ratio
Analyzing the Final Stock Price
The final stock price that was determined was $27.94. This was about $6 higher than the stock price that was determined from the Free Cash Flow Model. This model also does not use the growth rate of sales. This is a great comparison that the FCF model has a very similar price.
Figure 5: Competitors for Market Multiples in Apparel Retail Industry based on FactSetSource: FactSet
Figure 6: Market Multiples, Multiples Calculation using Value Line data and the stock price form November 30,2023. Source: Value Line & Yahoo Finance
Figure 7: Observations and Outliers to determine stock price using Market Multiples MethodSource: Value Line & Yahoo Finance
Excel Spreadsheet:
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