Woolworths Case Study

1. Executive summary

Risk can be defined as the uncertainty of a negative event occurring, coupled with an exposure to that event. In putting it differently, risk can be viewed as the size of a loss plus the probability of the loss occurring. Effective risk management practice is therefore necessary for creating economic value in a firm by using financial instruments to manage exposure to risk.

The purpose of this study is to analyze the fairness of the current share price and 2) the management of the share price of Woolworths for the future and to analyze the risk position of Woolworths and provide recommendation regarding the effective management of risk within this organization. A statistical analysis tools will be used to assess the risk at Woolworths and also give recommendation if whether it makes sense to hold an investment portfolio that comprises of 50% shares in Woolworths and 50% shares in the market.

1. Evaluation methods

For a listed company like Woolworths, the most important factor that drives the share price is profitability, also known as earnings. The important profit statistic for shares is the earnings per share (EPS), and it’s normally expressed in cents per ordinary share. It is also generally accepted that when earnings increases, the share price rises and when the earnings decrease the share price also falls, however the correlation is not usually the exact one.

It is for this reason that the earnings yield for Woolworths and the Market was tabulated and compared to calculate Beta which is a slope of the “characteristic” line, or the regression line showing the relationship between a Woolworths stock and the stock market.

Part 1:

1. Objective: Calculate if whether the share price based on historical data is fairly priced.

Calculation of Beta for Woolies

Table1. Earnings yield for the market and Woolworths

From the earnings yields above, a chart was drawn to determine beta

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Fig1. Woolworths VS Market

From figure 1 above, beta which is a slope coefficient is calculated to be 0.4025 and indicate relative volatility of a Woolworth’s stock relative to the stock market, in our case Woolworth’s stock is not highly volatile relative to the market, a highly volatile stock will be indicated by a Beta of 1.

Calculation of the required rate of return ( ř )

E(R) = rf + β(rm - rf) = 8.4+0.4025(14 - 5) = 12.0% required (expected) rate of return

The rule of thumb says:

From the information above it is evident that Woollies shares are undervalued, an undervalued stock is simply a stock that is selling at a price significantly below what is assumed to be.

Motivation:

In the period 2004 to 2013 Woolies shares seems to be undervalued, the reason behind this major deep in Woolies share price could be due to the fact that on 26 November 2008, the trading of shares in Woolworths Group PLC was suspended and Woolworths and Entertainment UK subsidiaries entered administration. Woolworths PLC entered administration on 27 January 2009; Diloitte who was the administrators closed all 807 Woolworth’s stores between 27 December 2008 and 6 January 2009 resulting in 27000 job losses. This could be a reason for the undervaluing of Woolworths share price, the credit crisis of 2009 could have also played a part.

1. The management of the share prices of Woolworths for the future what would your advice be?

Current share price

Variance (Ơ2) = 13439.9/(10-1) =1493.3                 Variance(Ơ2) = 3399.9/(10-1) =377.8