Question

• Emerson Electric common stock that is selling for $80 with a par value of $5. This stock recently paid a $2.10 dividend, and the firm’s earnings per share have increased from $2.40 to $4.48 in the past 5 years. An equivalent amount of growth in the dividend is expected.

The required rate of return for the stock is 15%

Answer 1

The current annual dividend amounts to a 2.10/80 = 2.63% yield

The earnings growth at a rate of a factor of
4.48/2.40 = 1.8667 = (1+r)^5
amounts to appreciation in value at an annual rate given by
(1/5)ln(1+r) = ln 1.8667
r = 13.30%
The total return is 15.93%

The stock is fairly valued at $80 if a return of 15% is required

Answer 2

I personally would factor in risk as part of the return. For a stock which has an earnings growth of 13.3 percent, future competition and other factors surely presents a risk.

Answer 3

I failed to include the value of retained earnings, currently 5.6% of market price. (P/E ratio = 17.9; forward P/E = 15.8) This makes the stock somewhat attractive, but no great bargain, at $80. If one can believe the earnings trend will continue, it is fairly valued by historic P/E standards.

BobPursley is quite right however. Past performance is no guarantee of anything. Assessing risk is a very important part of investing.

They may want you to use some Benjamin Graham formula for Stock Valuation. I am no expert in that.