oracle papel
- 1. Investments 3033-003 Fernando Garcia Discount Rate & Valuation of AboutOracle,Inc. Co-Founder&Executive Chairman:LawrenceJ. Ellison CEO: Mark Hurd & SafraA. Catz Oracle Corporation wasfoundedin1977 and isheadquarteredinRedwoodCity,California. The company licensesitsOracle Databasessoftware to customers,which isdesignedto enable reliable andsecure storage,retrieval,andmanipulationof variousformsof data.The companyalsoprovidesarange of servicesinthree primarylayersof the cloud:Software asa Service,PlatformasaService,andInfrastructure asa Service. Itoffersarange of software for mobile computingtoaddressthe developmentneedsof businesses;and Java,a software developmentlanguage. Capital Asset Pricing Model n order to determine the valuation of Oracle (ORCL) I will calculate the discount rate to value ORCL. In order to determining the discount rate I will use CAPM equation whose inputs include the Risk free rate, Market Risk Premium, and the Beta, in this following order. CAP-M (Ke = Rf + MRP * Beta) So lets begin with the Risk Free Rate… Risk Free Rate The risk free rate, which plays a critical role on the yield rate of the 10-year Treasury, has been low. The current rate is at 1.84% (as of April 28, 2016 next release is on May 2nd) but historically tends to stay below 2%. In my opinion, the only right thing to do is to normalize the rate because of many reasons. The Fed decisions are rarely known, but according to the Musing on Markets article, it is said that it seems the Fed has an implicit message that lower risk free rates are good for the economy and the markets. They also say that the normalized risk free rates are generally computed by looking at the past average 10-year Treasury rate over the last 30 years, which you can see below (starting at Jan. 1986-2016) I
- 2. Principles of Investments have been relatively dropping. They are correct, but in the article they state and argue that it is the wrong approach and I beg to differ. The only reason why I do not agree is because, although they may be right, I rather be safe than sorry in this occasion. With also the interest rates not being the same as before the 4% normalized risk free rate rather than the actual low rate you may not get the value you expect for your risky assets but it saves you from the cyclical ups and downs of the economy with risk free assets. I feel that it is not a way that it should always be because your returns will not have much growth and may affect the risk premium for risky asset classes, but I feel it is good to have some assets with normalized risk free rates just to be safe in your portfolio. You could also compare these rates to those of a Aaa and Baa corporate bond yield for the past 10 years. Although, Aaa is the best quality of a bond and Baa is a medium- grade quality you could see that entering 2010 both bonds’ yield dropped and are artificially low. Therefore, with my opinion and argument on normalized risk free rates I will use a normalized 10-year Treasury. With my chart up above, I too, believe that long term the 10-Year Treasury has yielded 1% below the expected nominal GDP growth. According to my chart below (Conference Board forecast) I will assume GDP will be 2% since the job growth over the past months have been pretty disappointing and the fall of oil prices this year affecting the oil and gas job market I believe it will be; 1% productivity growth and 1% labor growth making Real GDP 2% minus 1% equaling 1%. Using the Components of Nominal GDP Growth by Decade as a reference and after the downward months we’ve recently had I assume the Federal Reserve to raise
- 3. Principles of Investments interest rates, which I believe will increase from the 2.1% inflation in 2015 to 2.4%. Therefore, agreeing with Ron Sweet’s theory equation my risk-free rate equal 3.4% and my Nominal GDP equal 4.4%. So now, that leads us to determining our Market Risk Premium… Market Risk Premium For the Market Risk Premium I will be using the Implied Approach, which makes the MRP correlate with my risk free rate. With the Implied Approach, Expected Return on Stocks will equal to the Current Dividend Yield plus the Expected Earnings Growth of the U.S. The Current Dividend yield of the market is at 2.1% and Expected Earnings Growth to be 4.4%. My estimated Productivity Growth being 1% plus 1% Labor Growth plus 2.4% inflation. Making my long-term growth in earnings or Expected Return on Stocks equal 6.5% (2.1% + 4.4% = 6.5%). MRP = Expected Return Stocks – Risk Free Rate Market Risk Premium: .065 - .034 = 3.1% Now, for the final piece of the equation, Beta… Beta I will be discussing and determining the four components of Oracle’s beta. 1. Revenue Sensitivity 2. Operating Leverage 3. Financial Leverage 4. History 1. Revenue Sensitivity Oracle is a technology company which makes its stock a tech stock. Tech stocks generally tend to have high beta’s (>1) making it a cyclical stock. Since it is cyclical it will not hold up well in a recession due to it being vulnerable to the economy but will do good in a recovering economy. 2. Operating Leverage Oracle has a relative low fixed cost and as you can see in the chart below its Net and Gross Margin are below than that of the average S&P 500 as well, making them steady. Which makes me believe beta is right at 1 or very slightly above. 3. Financial Leverage Gross Margin Standard Deviation (%) S&P 500 ORCL UN Equity Rank Median 3.53 1.78 22.6% 90 Precentile 13.56 10th Percentile 1.06 Net Margin Standard Deviation (%) S&P 500 ORCL UN Equity Rank Median 5.37 1.78 14.3% 90 Precentile 57.38 10th Percentile 1.41
- 4. Principles of Investments Oracle’s debt is slightly below average. Making me believe that the beta is very close or around 1. 4. History History implies that beta rose well above 1 ever since the aftermath of the financial crisis in ’08 and has stayed at 1 or well above. Comparing my chart with that of Zach Mueller, oracle has shown a trend in the latest year of a beta in between 1.10 to 1.20. I will go with the long term trend and forecast that beta is 1.18. I will be using the CAP-M equation to determine the discount rate of Oracle. CAP-M (Ke = Rf Rate + MRP * Beta) = .034 + .031 * 1.18 = .0767 or 7.67% Now we will be using the discount rate we calculated to determine the value of Oracle. Debt to Equity S&P 500 ORCL UN Equity Rank Median 52.58 51.40 49.1% 90Precentile 258.49 10th Percentile -
- 5. Principles of Investments In this paper I will determine the valuation of Oracle using three valuation models. The Gordon Growth Model, Capitalized Earnings Model, and the H Model. But first, in order to find an answer to these models we must first find the inputs of our stock, Oracle. The inputs consist of the stocks Dividend 0 (ttm), Earnings Per Share (EPS) 0 (ttm), Long-term Growth Rate, Inflation Assumption, Short-Term Growth Rate, and the time period for getting from short-term to long-term growth. Now, let’s start with finding these inputs… Inputs for the Valuation of Oracle The Dividend 0 (ttm) and EPS 0 (ttm) for Oracle, according to yahoo finance, is .60 and 2.07. The Long-term Growth Rate for Oracle I assume should be the same calculation for the function of the US economy or Nominal GDP growth which is 4.4%. Mainly because it is the direction Oracle will be heading depending on the economy, in which I believe will be positive, because it is a tech company and being in this generation technology is enhancing more and more every day. With the software that Oracle could provide to all the different sectors because every job now a day uses technology, this could mean positive growth for Oracle. Since I concluded that inflation will be 2.4% in the near future for Nominal GDP growth I will use that as my inflation assumption. The Short-term growth rate consists of three things; the PEG Ratio Approach, Sustainable Growth, and the Historical Growth. To calculate the PEG ratio, it consists of a formula that is, PE Ratio/PEG Ratio which should equal expected Short-term growth. For Oracle the PE ratio equals 19.22, PEG ratio equals 2.27, and if you divide those two it will equal to a short-term growth of 8.5%. To get a Sustainable Growth you must multiply Return on Equity by Retention, where Retention equals 1 minus dividends divided by Earnings Per Share. When you solve that out, from our previous input dividends equals .60 and our EPS equaled to 2.07. Now, if you divide those two and subtract by 1 you will receive 71%. So now, we look at our ROE on yahoo finance which is, 19.51% and you multiply that by our retention we just calculated and should receive a Sustainable Growth of 14%. Now for our historical growth as you can see in our graph the EPS have had a drastic drop in the 90’s but have stayed fairly consistent during the 2000’s, so I’m going to say that our Short-Term Growth is 10%. Now for our last input, which is the time period for getting from Short-Term to Long- Term Growth. I believe that since it is like I
- 6. Principles of Investments have stated before, a technological company, there are many competitors out there such as leading leaders which consist of companies such as Google, Apple, Dell, and so forth. With U.S. competing against other countries such as China and Japan for leading technological companies Oracle has a lot of competition out there and they are rapidly expanding but they must come up with a software that will set them apart to put Oracle above all competitors. So with that, I forecast that Oracle’s Long-Term growth will be about 14 years. Making their H equal 7. Now that we have all of our inputs and data of the Article we can start with our 3 different models. Let’s start first with the Dividend Discount Model… Dividend Discount Model: Value = (Div0 * (1 + LT Growth)) / (ke – LT Growth) (.60 * (1 + .044)) / (.0767 - .044) = $19.16 Next, the Capitalized Earnings Model… Capitalized Earnings Model: Value = (EPS0 * (1 + Inflation)) / (ke – Inflation) (.0207 * (1 + .024)) / (.0767 - .024) = $.40 Lastly, our H model… H Model: Value = (Div0 * (1 + LT Growth) + Div0 * H * (ST – LT)) / (ke – LT) (.60 * (1 + .044) + .60 * 7 * (.10 - .044)) / (.0767 - .044) = $26.35 Oracle currently trading for: $39.86 So, to conclude I recommend that Oracle is a strong buy due to it pricing lower than the current price and the positive trend it may have in the future.