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Guess What: It's Time to Get Away from This World-Renowned Fashion Brand
Posted by: Victor Selva (IP Logged)
Date: February 18, 2014 05:09PM

Guess? Inc. (GES) offers contemporary apparel and accessories for men, women and children, sold in multiple channels including wholesale, company-owned retail locations, e-commerce and licensed stores. The firm's largest competitors include Ralph Lauren (RL), The Gap Inc. (GPS) and Abercrombie & Fitch Co. (ANF).

Turning our attention to the future direction of the stock, let's take a look at the intrinsic value of this company and try to explain to investors the reasons why it is a good buy or not.

Valuation

In stock valuation models, dividend discount models (DDM) define cash flow as the dividends to be received by the shareholders. Extending the period indefinitely, the fundamental value of the stock is the present value of an infinite stream of dividends according to John Burr Williams.

Although this is theoretically correct, it requires forecasting dividends for many periods, so we can use some growth models like: Gordon (constant) growth model, the Two or Three stage growth model or the H-Model (which is a special case of a two-stage model).

To start with, the Gordon Growth Model (GGM) assumes that dividends increase at a constant rate indefinitely.

a) Required Rate of Return (r)

The capital asset pricing model (CAPM) estimates the required return on equity using the following formula: required return on stock j = risk-free rate + beta of j x equity risk premium

Assumptions:

1. Risk-Free Rate: Rate of return on LT Government Debt: RF = 2.67%

2. Beta: β =1.73

3. GGM equity risk premium = (1-year forecasted dividend yield on market index) +(consensus long-term earnings growth rate) – (long-term government bond yield) = 2.13% + 11.97% - 2.67% = 11.43%[1]

rGES = RF + βGES [GGM ERP]

= 2.67% + 1.73 [11.43%]

= 22.44%

b) Dividend growth rate (g)

The sustainable growth rate is the rate at which earnings and dividends can grow indefinitely assuming that the firm's debt-to-equity ratio is unchanged and it doesn't issue new equity.

g = b x ROE

b = retention rate

ROE can be estimated using the Dupont formula:

Because for most companies the GGM is unrealistic, let's consider the H-Model which assumes a growth rate that starts high and then declines linearly over the high growth stage until it reverts to the long-run rate, a smoother transition to the mature phase growth rate that is more realistic.

c) Dividend growth rate (g) implied by Gordon growth model (long-run rate)

The growth rates are:

 Year Value g(t) 1 g(1) 6,50% 2 g(2) 9,67% 3 g(3) 12,84% 4 g(4) 16,01% 5 g(5) 19,19%

G(2), g(3) and g(4) are calculated using linear interpolation between g(1) and g(5).

d) Calculation of Intrinsic Value

 Year Concept Amount Present value 0 Div 0 0,80 1 Div 1 0,85 0,70 2 Div 2 0,93 0,62 3 Div 3 1,05 0,57 4 Div 4 1,22 0,54 5 Div 5 1,46 0,53 5 Terminal Value 53,34 19,38 Intrinsic value 22,35 Current share price 29,27

Final Comment

When the stock price is higher than the intrinsic value, the stock is said to be overvalued and it makes sense to sell the stock. I would advise fundamental investors to consider getting away from this stock, according to our estimations.

Hedge fund gurus have also been active in the company. Paul Tudor Jones (Trades, Portfolio), Jim Simons (Trades, Portfolio), Chuck Royce (Trades, Portfolio) and NWQ Managers (Trades, Portfolio) have sold or reduced the stock.

Disclosure: Victor Selva holds no position in any stocks mentioned.

[1] This values where obtain from Blommberg´s CRP function.

Guru Discussed: Chuck Royce: ,
Jim Simons: ,
Stocks Discussed: , , , ,
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