There are a number of places that you can go to find data such as
historical earnings and dividends. One such place is Harley Davidson?s
own investor relations page; another is the SEC Edgar database:
Data is usually available for several years in the Form 10-K or annual
report. For longer periods of data, it?s a good idea to use Standard
& Poor?s company reports or another service (like Value Line). These
services are often better because they?ll have a ?beta? for the
company ? something I?ve never seen in a annual report for Form 10-K.
WHAT IS BETA?
Beta is a measure of the volatility of the company as compared to the
market. A beta of more than 1.0 means that as the stock market goes
up (or down) the firm will move MORE than the market average. A beta
below 1.0 means a ?lower risk? firm that isn?t as dramatically
affected by economic changes. Historically these have been food or
utility companies, where economic or market changes have less impact
on their businesses.
Here?s a good discussion of cost of capital and beta that?s quite to the point:
?The Risk Premium Project Releases Empirical Results,? (Francis, February 2004)
Note the key formula:
Rc = rf + ßc(rM - rf)
Rc is the company's expected return on capital
rf is the risk-free return rate, usually a long-term U.S. Treasury bill rate
rM is the expected return on the entire market of all investments.
This is actually the toughest number, so often it?s the return on the
S&P500 over the past 5 or 10 years ? and some people suggest adding 3%
to the risk-free rate.
ßc is the company's Beta, based on its covariance with the market.
Most commonly it?s measured as co-variance with the S&P500, as it?s
one of the broadest market indices. However, even then you?ll see
slightly different numbers for a ?beta,? as some methods calculate it
over 1 year, others over 3 years and still others over 5 years.
HARLEY DAVIDSON (HDI)
Now let?s get you some hard data on the company and markets to use:
** T-BILL RATE
Rf is 4.31% on a 10-year Treasury bill according to today?s Wall
Street Journal. It?s about 4.7% if you want to use a 25-year T-bill
** HDI BETA
ValueLine measured it at 1.1 in its most-recent report.
** HDI DIVIDENDS
Before 1993 there were none.
So you?ve seen dividend growth of 1950% in 11 years or a compounded
growth rate of 31.6%. Here?s your first choice in the ?future
dividend? model ? you can use that ?compounded growth rate? or perhaps
an average of the following numbers:
** HDI DIVIDEND GROWTH RATES
Before going on to market risk, I have to look at HDI earnings.
Dividends have grown at a great rate but if earnings aren?t growing as
fast it would be a good idea to adjust downward the implied rate of
dividend growth. Dividends can?t grow faster than earnings or at some
point they will begin liquidating the firm ? but that?s a whole
Here are the earnings for the same period, expressed in Earnings Per
Share (EPS), along with a growth in percent:
1993: $0.24, 26.3%
1994: $0.34, 41.7%
1995: $0.37, 8.8%
1996: $0.48, 29.7%
1997: $0.57, 18.8%
1998: $0.69, 21.1%
1999: $0.87, 26.1%
2000: $1.13, 29.9%
2001: $1.43, 26.6%
2002: $1.90, 32.9%
2003: $2.50, 31.6%
2004: $3.00, 20.0%
You can use the average of these growth rates ? or the 25.8%
compounded growth rate from 1993 to 2004 ? but as you can see it?s
less than the dividend growth rate. So, it would be unwise to use the
dividend growth rate in your Dividend Discount Model, unless you
forecast Harley Davidson to go out of business in the next 10 years.
rM or market returns are most-often used against a broad-based index
and most-often against the Standard & Poor?s 500 index, as it
represents a heavy percentage of the equity value in the U.S. markets.
The following are annual returns to the S&P500. Again you can use
the compound number or an average. Remember that costs of capital are
an ESTIMATE and that there are arguments for using either:
1993: 466.5, 7.1%
1994: 459.3, -1.5%
1995: 615.9, 34.1%
1996: 740.7, 20.3%
1997: 970.4, 31.0%
1998: 1,229.2, 26.7%
1999: 1,469.3, 19.5%
2000: 1,320.3, -10.1%
2001: 1,148.1, -13.0%
2002: 879.8, -23.4%
2003: 1,111.9, 26.4%
2004: 1,211.9, 9.0%
Compounded, that?s about 9.1% annual growth in the S&P500 over the 11-year period.
So, there you go: plug the numbers of your choice into your growth
model and estimate the price for HDI. (Here?s a hint: it closed at
$47.46 today, up $2.04.)
Google search strategy:
CAPM + beta + WACC
?Capital asset pricing model? + beta
Clarification of Answer by
22 Apr 2005 06:04 PDT
COMPOUNDED GROWTH: We have 11 years of dividend data, so you can use
beginning and ending numbers to calculate a dividend growth rate.
Here's how you do it:
2 cents * (1.316 ^ 11) = 41 cents
The terms here are:
1. beginning dividend
2. the growth factor -- with the number to the right of the decimal
3. ^ 11 is 1.316 multiplied by itself 11 times -- or 1.316 to the
11th power. If you want to do these calculations yourself (for
earnings or other measures), just set the terms up in a spreadsheet.
4. 41 cents: the ending dividend
I cited the obviously problems with this -- the low base -- and that
fact that earnings aren't growing that fast. But you'll probably make
big points with the professor if you mention the calculation, then
explain why you DID NOT use that number.
WHY 3%? Capital returns are important within financial markets but in
evaluating a firm or in making business decisions, one percent or two
makes little difference, as other factors will outweigh a 10% or 20%
change in capital. I believe that it was Warren Buffett, certainly
one of the most-astute investors of modern times, who said "we just
add 3% to the interest rate." In 'normal' years you'll see interest
rates of 5%-8% and corporate returns of 8% - 12% and so it's a good
rule of thumb.
FINALLY, PRICE: The closing price today indicates the votes of
thousands (millions?) of investors as to:
* future rf
* future rm
* future dividend growth of HDI
As you plug-and-chug different numbers and get widely different
valuations, I'd always remember that HDI traded between $45.20 and
$63.80 in the past year. If you come up with values outside that
range, I'd change my statistical assumptions. Markets are efficient
and all that.
Harley Davidson is a good case model: it's considered to be a
well-managed company with good earnings predictabiity. By the way, if
you want some additional data to work with, I'd strongly suggest
picking up the one-page Value Line summary. It's in virtually any
public library and the last analysis was written Feb. 18, 2005.