Entering Estimates into Residual Earnings Model

Contents - Index

Entering Estimates into Residual Earnings Model
©2009 OS Financial Trading System

In this topic we will now enter our personal estimates into the FTS Real Time Client's analytical support for the Residual Earnings Model. Recall, the summary of our inputs is:

Inputs
I. Book value per share = 15,380/1,310.88 = $11.73258 per share.
II. Dividend per Share = $2.10.
III. Dividend Payout Ratio (Relative to Comprehensive Earnings) = $2.10/$4.7113 = 0.446
IV. Earnings per share = $12,648/1,310.88 = $9.648
V. Comprehensive Earnings per share = $4.7113
VI. Comprehensive EPS 1 year from now $4.7113*1.09775 = $5.1718, Growth 0.09775
VII. Comprehensive EPS 2-years from now $4.7113*1.09775*1.10675 = $5.724, Growth 0.10675
VIII. 5-Year Growth = 0.11465
IX. Normal Growth = 0.045
X. Projected Dividend Per Share (Next Year - forward annual dividend rate e.g., Yahoo.com) = $2.20
XI. Years in Abnormal Growth Stage 1: 5-years
XII. Cost of equity capital (stages 1 and 2): 0.086

First, in the FTS Real Time Trader click on Menu item Parameters,

The values can be entered either manually or as a group from Excel. Once entered they are automatically stored on the FTS Server until you choose to delete or override with different inputs.
Tip: The Parameter menu item lets you store your current working set so that if you have multiple parameter sets you should keep other sets in your personal Excel workbook.
Entering Personal Values to Override FTS Default Values
Step 1: Click on List All above and then select IBM as the security from the dropdown and then select the Residual Earnings Model

Step 2: Select the Parameter Fields dropdown

Step 3: For Parameter Field you can select all inputs depicted above and enter your personal override values. Once completed your screen will appear as follows:

You can verify the numbers from the summary inputs above.
Finally be careful to Check the Checkbox "Use these values in my analytical support"
The main trading screen now appears as follows:

Interestingly our first pass estimate is a little higher ($127.71) than the current market price but much closer than our FCFE analysis would suggest. Overall we have applied relatively conservative estimates for IBM - especially in terms of the life of Stage 1 abnormal growth phase. In reality we expect IBM to exhibit abnormal growth for longer than 5-years! So for a long term patient investor this is a very conservative assumption that if relaxed would lead to assessing an even higher intrinsic value for IBM. Another major issue that appears to arise with IBM is estimating it's Comprehensive Earnings. This clearly requires much attention by analysts who follow this stock as it involves assessing human capital costs accurately.