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Assignment 2: Case Study Evaluation of an Equity Research Report on Kmart Corporation Equity research reports conclude with a stock recommendation.
Assignment 2: Case Study Evaluation of an Equity Research Report on Kmart Corporation Equity research reports conclude with a stock recommendation.
Assignment 2: Case Study Evaluation of an Equity Research Report on Kmart Corporation Equity research reports conclude with a stock recommendation. The invest or reads the body of the report to be persuaded that the analysis in the report justifies the recommendation. She asks herself: Is the report credible? Is it internally consistent? Is there an imperative for the recommendation? Does the report give me a feeling of security in following the recommendation? Reports all too often fail to give reassuring answers to these questions. And sometimes they exhibit inconsistencies and fallacies that reveal a lack of craftsmanship in how analysis is done. Below are excerpts from an equity research report on Kmart Corporation, the discount retailer that is a close competitor of Wal – Mart. You might review the firm’s web page at www.kmart.com before beginning the case. KMART C ORP. March, 1999 (NYSE: KM) Current Price per share: $17 Recommendation: BUY Kmart Corp. is the second largest discount retailer in the United States and the world’s third largest general merchandise retailer. It operates departmen t stores in all 50 states in the United States and in Puerto Rico, the U.S. Virgin Islands and Guam. Some pertinent data for 1999 fiscal year ending January 31 are below. 1999 Earnings $518 million Dividends 0 Common equity $5,979 million Debt $2,706 million Cash flow from operations $1,427 million Cash investments $795 million
Assignment 2: Case Study Evaluation of an Equity Research Report on Kmart Corporation Equity research reports conclude with a stock recommendation.
Forecast:
We forecast the following earnings and book values per share for fiscal years ending January 31, 2000 and 2001, along wit h forecasts of P/B ratios and P/E ratios. 1999A 2000E 2001E Eps 1.05 1.23 1.41 Bps 12.12 14.02 15.43 Shares outstanding ($ millions) 493.4 493.4 493.4 Price – to – book ratio 1.40 1.36 1.38 Price – earn ings ratio 16.2 17.1 20.0 We forecast eps to increase at 6% per year after 2001. We also forecast free cash flow to grow at 6% per year from 1999 onwards. Risk: We give Kmart a Beta of 1.15 and a required return of 12% per year. Recommendat ion: Our recommendation is based on the ability of the firm to grow its earnings and grow its P/E ratio. By 2001, we expect earnings to be fully flowing from its recent development of Superstores in major metropolitan areas, and see no reason why Kmart’s shares should not be trading at a P/E of 20, the current average earnings multiplier for U.S. discount retailers. What is wrong with this report?
