analysis as of june 1st, 2008
TRANSCRIPT
Analysis as of June 1st, 2008
Analysis Team
Kent McCarty [email protected]
Chris Wallace [email protected]
Chase Coleman [email protected]
Tom Fouts [email protected]
Table of Contents
Introduction to Business and Industry Analysis ...................................... 14
Business Overview ............................................................................ 16
Industry Overview ............................................................................ 19
Five Forces Model ................................................................................ 20
Rivalry Among Existing Firms ............................................................. 20
Industry Growth Rate ..................................................................... 21
Industry Concentration ................................................................... 23
Degree of Differentiation ................................................................ 24
Switching Costs ............................................................................. 25
Economies of Scale ........................................................................ 26
Learning Economies ....................................................................... 27
Fixed-Variable Costs ....................................................................... 27
Excess Capacity ............................................................................. 28
Exit Barriers .................................................................................. 29
Conclusion .................................................................................... 30
Threat of New Entrants ..................................................................... 30
Economies of Scale ........................................................................ 31
First Mover Advantage ................................................................... 32
Distribution Access and Relationships .............................................. 33
Legal Barriers ................................................................................ 33
Conclusion .................................................................................... 34
Threat of Substitute Products ............................................................ 35
Relative Price and Performance ....................................................... 35
Buyer’s Willingness to Switch .......................................................... 36
Conclusion .................................................................................... 37
Bargaining Power of Customers ......................................................... 37
Price Sensitivity ............................................................................. 38
Relative Bargaining Power .............................................................. 38
Conclusion .................................................................................... 39
Bargaining Power of Suppliers ........................................................... 39
Price Sensitivity ............................................................................. 39
Relative Bargaining Power .............................................................. 40
Conclusion .................................................................................... 40
Value Creation Analysis ........................................................................ 41
Economies of Scale and Scope ........................................................... 42
Research and Development ............................................................... 43
Superior Product Quality and Variety .................................................. 44
Investment in Brand Image ............................................................... 44
Conclusion ....................................................................................... 45
Competitive Advantage Analysis ........................................................... 46
Superior Product Quality and Variety .................................................. 46
Superior Customer Service and Flexible Delivery ................................. 47
Research and Development ............................................................... 49
Investment in Brand Image ............................................................... 50
Conclusion ....................................................................................... 52
Formal Accounting Analysis .................................................................. 53
Key Accounting Policies ..................................................................... 54
Research and Development ............................................................ 55
Goodwill ........................................................................................ 55
Operating leases ............................................................................ 56
Pension Plans ................................................................................ 58
Foreign Currency ........................................................................... 61
Potential Accounting Flexibility ........................................................... 62
Research and Development ............................................................ 63
Goodwill ........................................................................................ 63
Operating Leases ........................................................................... 64
Pension Plans ................................................................................ 64
Conclusion .................................................................................... 65
Accounting Strategy .......................................................................... 65
Qualitative Disclosure ........................................................................ 67
Quantitative Disclosure ..................................................................... 70
Sales Manipulation Diagnostics .......................................................... 71
Net sales/Cash from Sales .............................................................. 71
Net sales/Accounts Receivable ........................................................ 72
Net sales/Inventory ........................................................................ 73
Expense Manipulation Diagnostics ...................................................... 75
Asset Turnover .............................................................................. 75
Cash Flows from Operations/Operating Income ................................ 76
Cash Flows from Operations/Net Operating Assets ........................... 78
Pension Expense/SG&A .................................................................. 79
Conclusion .................................................................................... 80
Potential Red Flags ........................................................................... 80
Undo Accounting Distortions .............................................................. 82
Financial Analysis, Forecasting Financials and Cost of Capital Estimation .. 84
Financial Analysis .............................................................................. 84
Liquidity Analysis ........................................................................... 84
Current Ratio .............................................................................. 85
Quick Asset Ratio ........................................................................ 87
Accounts Receivable Turnover ...................................................... 89
Days Sales Outstanding ............................................................... 91
Inventory Turnover ..................................................................... 93
Days Supply of Inventory ............................................................. 95
Working Capital Turnover ............................................................ 97
Cash to Cash Cycle ...................................................................... 99
Conclusion ................................................................................ 100
Profitability Analysis ..................................................................... 101
Gross Profit Margin ................................................................... 101
Operating Profit Margin ............................................................. 103
Net Profit Margin ....................................................................... 105
Asset Turnover ......................................................................... 107
Return on Assets ....................................................................... 109
Return on Equity ....................................................................... 111
Altman’s Z-score ....................................................................... 115
Conclusion ................................................................................ 116
Capital Structure Ratios ................................................................ 117
Debt/Equity Ratio ...................................................................... 117
Times Interest Earned ............................................................... 118
Debt Service Margin .................................................................. 119
Cost of Capital Estimation ................................................................ 120
Cost of Equity .............................................................................. 120
Alternate Estimate of Cost of Capital ............................................. 123
Cost of Debt ................................................................................ 124
Weighted Average Cost of Capital ................................................. 125
Financial Statements Forecasting ..................................................... 126
Income Statement ....................................................................... 126
Restated Income Statement ......................................................... 131
Balance Sheet.............................................................................. 135
Restated Balance Sheet ................................................................ 139
Statement of Cash Flows .............................................................. 142
Valuation Analysis ........................................................................... 148
Method of Comparables .................................................................. 148
Price/Earnings (Trailing) ............................................................... 149
Price/Earnings (Forecast).............................................................. 149
Price/Book ................................................................................... 150
Dividend/Price ............................................................................. 150
P.E.G. ......................................................................................... 151
Price/Earnings Before Interest, Taxes, Depreciation, and Amortization
.................................................................................................. 152
P/FCF.......................................................................................... 153
Enterprise Value/EBITDA .............................................................. 154
Intrinsic Valuations ............................................................................ 155
Discounted Dividends Model ............................................................ 155
Residual Income Model ................................................................... 157
Discounted Free Cash Flows Model .................................................. 161
Abnormal Earnings Growth A.E.G. .................................................... 165
Long Run Residual Income Model .................................................... 168
Appendices ....................................................................................... 175
References ........................................................................................ 203
Executive Summary
Investment Recommendation: Fairly Valued, Hold or Buy
(6/1/2008) CLX-NYSE (6/1/08) $57.13 Altman Z-Scores
52 Week Range $51.61- 66.90 2003 2004 2005 2006 2007Revenue $5.12B 2.93 3.21 3.19 3.45 2.06
Market
Capitalization $7.14B
Shares Outstanding 151.26M Market Price(6/1/2008) 57.13
Financial Valuations
Initial Revised Initial Revised Trailing P/E 61.14 58.81
Book Value per Share -3.424 1.131 Forward P/E 59.85 48.01
ROE -49.8% 6.9% P.E.G. 59.95 54.35
ROA 13.9% 12.75% P/B N/A N/A
P/EBITDA 10.61 N/A
P/FCF 56.64 N/A
Cost of Capital EV/EBITDA 37.65 N/A
D/P 64.78 N/A
Estimated
R-
Squared Beta Ke
3-Month 13.38% 0.58 7.21% Intrinsic Valuations
6-Month 13.41% 0.58 7.22% Discounted Dividends 79.95 N/A
2-Year 13.51% 0.58 7.23% Free Cash Flows 421.01 425.19
5-Year 13.60% 0.58 7.23% Residual Income 60.26 57.56
10-Year 13.59% 0.57 7.18% LR ROE RI 17.17 1.26
Alternate Method 14.91% A.E.G. 60.97 57.77
Industry Overview
The Clorox Company (CLX) was founded in 1913 when a group of 5
California entrepreneurs: Archibald Taft, Edward Hughes, Charles Husband,
Rufus Myers, and William Hussey contributed $100 in capital each to form
the first liquid bleach factory in the United States. The factory was located
in Oakland, California, where they began producing industrial strength
bleach. The company has since grown from producing domestically, to
producing on a global scale. Their main competitors in the household
cleaner industry are Protor & Gamble, Colgate-Palmolive, and Johnson &
Johnson.
The household cleaner industry is a highly competitive industry,
where bigger is better. The larger companies all produce a similar product
with very little differences, so advertisement and brand image are key
elements to success. Research and development is also another key
element due to consumers always searching for something better.
Consumers will always need the products from this industry, and that
keeps the companies competing at low costs and spending a lot of money
on advertisement.
Along with high rivalry in the household cleaner industry, there is a
low threat of new entrants and a high threat of substitute products. Firms
have a high degree of bargaining power over suppliers, but a low degree of
bargaining power over buyers because companies need to have their
products on the shelves of large retail stores.
Since the products in this industry are very similar, the key success
factors include brand image, product differentiation, and cost leadership. A
company needs to be able to set itself apart from their competitors to
ensure profit growth and survival in the long run. A profitable company in
this industry must appeal to the consumers while maintaining cost
leadership.
Accounting Analysis
The accounting analysis is a tool used by investors to assess how
well a company’s financial statements portray a true image of the
company’s performance. It is necessary for a company to disclose
information to the public so that the financial statements can be analyzed
for any distortions or misrepresentations. There are many ways a
company can distort financial information while remaining in the guidelines
of the SEC. This can give shareholders a false sense of security and lead
investors to make poor decisions.
There are six steps in the accounting analysis, which are: key
accounting policies, accounting flexibility, accounting strategy, disclosure,
identifying potential red flags, and accounting distortions. After analyzing
Clorox’s financial statements and their 10-K, it is apparent that Clorox is a
high disclosure company that uses an aggressive accounting strategy. This
is evident in that Clorox provides an ample amount of information in their
10-K, explaining the methods they used to get the numbers on their
financial statements. Also, Clorox shows they use an aggressive approach
to accounting by the way they do not impair goodwill, which makes the
financial statements appear to be better than they really are. Since the
goodwill takes up a major part of total assets, and management chooses
not to impair it, a potential red flag was identified. The financial
statements were restated, impairing goodwill by 20% a year for 5 years, to
portray a more accurate picture of the company’s financial performance.
Financial Analysis, Forecasting, and Cost of Capital Estimation
To have a more accurate valuation of Clorox, a financial analysis was
performed that calculated the company’s liquidity ratios, profitability ratios,
and capital structure ratios. To benefit from these ratios, properly
comprehending what they mean is crucial. Also, to more accurately
forecast the financial statements, calculating and comparing the ratios to
the competitors is another crucial element.
Firms use the liquidity ratios to determine how quickly they can turn
their assets to cash. When compared against the industry, Clorox
performed better than average. This firm is a very liquid firm and has the
ability to convert assets into cash in a very timely and efficient manner.
This overall makes the firm a more desirable and profitable company in the
long-run.
By comparing a company’s profitability ratios to that of their
competitors’, an investor can grasp a good idea of how well the company is
doing. Overall, Clorox is being outperformed by their competitors. A
significant reason for this is due to the company’s smaller size than their
competitors. Clorox is showing weaknesses at being better at cost
efficiency than their competitors.
When evaluating capital structure ratios, analysts are measuring how
a firm finances its overall operations and growth by using different sources
of funds. Clorox is being slightly outperformed in this area when compared
to their competition.
Using these ratios and the company’s trends, an accurate forecast of
the financial statements can be made. Clorox has a fiscal year end at June
30, so three quarters of data were available to forecast the year 2008, and
the company’s trends were used to forecast the years from 2009 to 2017.
Using the asset turnover ratio, the income statement and balance sheet
were linked together by using the relationship between net income and
total assets. The company was expected to continue to grow and increase
their profit margins and total assets over the next 10 years. Adjustments
were also made to the statements by impairing goodwill. This led to lower
profits; however, the company is still expected to grow.
The cost of equity was calculated by running regressions on the S&P
historical data, risk free treasury yields, and firm returns. The estimated
beta was .58. Using CAPM, the estimated cost of equity was 7.23%.
There was an alternative method used to estimate to cost of equity at
14.91% by using ROE, the growth rate of 11.25%, and the P/B ratio. The
weighted cost of debt was estimated at 4.39%, which yielded a WACC
before taxes of 6.46%.
Valuations
There were many different forms of valuation tests performed on
Clorox and their competitors. One type of test used were the methods of
comparables, which are the quickest and easiest ways to value a
company’s price per share. We used a 15% degree of tolerance during
these valuations. There seemed to be no conclusive evidence one way or
another to correctly value Clorox’s price per share because some of the
models showed their stock to be overvalued, while others showed the
stocks to be undervalued. However, the comparable with the most
explanatory power, forecasted P/E, showed that Clorox’s price was
overstated when using the restated financials. The prices ranged from
$10.61 to $64.78 using these eight methods, which shows how
inconsistent with each other they are. Given the inconsistency of these
prices, the methods of comparables proved to be an inaccurate form of
valuation.
The intrinsic valuation models heavily influenced our valuation of
Clorox. Of the five models, the Residual Income Model has the most
explanatory power. The model yielded an estimated price, $57.56, which
was almost exactly the market price of Clorox. The A.E.G. model also
calculated an estimated price, $57.77, which was almost equal to the
market price of Clorox’s stock. The models led to the assumption that
Clorox was fairly valued. The other intrinsic valuation models, however,
presented different information. The two tests that have little explanation
power and are very susceptible to changes in the growth rate, the
Discounted Dividend and Free Cash Flow Model, yielded estimated prices of
$79.85 and $425.19, respectably, which fall outside of our 15% range.
According to these estimates, Clorox is undervalued. The last model, the
Long Run ROE Residual Income model, yielded an estimated price of
$1.26, which also falls outside our 15% range. The estimated price was
calculated using a Ke of 7.23%, an average ROE of 6.9%, and a growth
rate of 10.2%. This model shows that Clorox is overvalued. Overall,
because of the conclusions of the two models with the most explanatory
power, the intrinsic valuation models show that Clorox is fairly valued.
Introduction to Business and Industry Analysis
The section is a basic overview of the firm, Clorox, and its industry,
the cleaning products industry. It covers Clorox, and how it relates to the
rest of the industry, including: products, growth of the firm, competitors,
market capitalization of Clorox, asset value, operations, history, and stock
price performance. The draft also analyzes the five-factor model of the
cleaning products industry, which shows the intensity of competition, and
the bargaining power firms have over customers and suppliers. It discusses
the success factors for value creation in the cleaning products industry, and
the competitive advantages that Clorox employs to reach these factors.
This section also gives a detailed look at the cleaning products
industry structure and profitability. The five-factor model shows how the
competition reacts to each other and the industry. The model also allows
people to view the economic power of both the input and output markets.
Another importance of this draft is the competitive advantage analysis. By
breaking down the goals of companies in the cleaning products industry a
person is able to decide where the industry stands, as far as, a cost
leadership competitive strategy, or a differentiation competitive strategy.
Once the success factors were known for the industry an analysis of how
well Clorox utilized the competitive advantages was done.
The cleaning products industry is a mature and highly competitive
industry. The industry is composed of companies that sell similar products
to comparable demographics. The cleaning products industry has low
switching costs and a low threat of new entrants. There is also a high risk
of substitute products in this industry. Customers have moderate to high
bargaining power, while suppliers have mixed bargaining power. Firms in
this industry use both cost leadership and differentiation competitive
strategies. The cost leadership strategies include: competitive pricing,
efficient production, and economies of scale and scope. The differentiation
strategies include: product performance and variety, investment in
research and development, and brand recognition. Clorox is able to utilize
these strategies successfully to compete in the cleaning products industry.
Business Overview
The Clorox Company (CLX) was founded in 1913 when a group of 5
California entrepreneurs: Archibald Taft, Edward Hughes, Charles Husband,
Rufus Myers, and William Hussey contributed $100 in capital each to form
the first liquid bleach factory in the United States. The factory was located
in Oakland, California, where they began producing industrial strength
bleach. At that time, Clorox was specializing in industrial strength bleach,
which would then be packaged in 5 gallon jugs and delivered by horse-
drawn cart. However, it wasn’t until 1916 with the formulation of a less
concentrated, household version of their industrial grade bleach that the
company began to take off. “Today, an estimated eight out of 10 American
households use Clorox® liquid bleach.” (www.thecloroxcompany.com)
The Company is divided into three different sections, household
group North America, specialty, and international. The household group is
perhaps the most familiar, included in this group are laundry additives and
home-care products to name a few. The specialty group consists of plastic
bags and wraps, cat litter, food products like Hidden Valley Dressings, and
charcoal. Finally, the international segment includes many of the same
items from the first two segments. The international segment accounts for
sales in two main international markets, Asia-Pacific and Latin America.
Clorox products compete on performance, brand recognition, price, and
quality.
Although the potential competitors of Clorox are abundant, its main
competitors include Johnson & Johnson (JNJ), Proctor & Gamble (P&G),
and Colgate-Palmolive (CL). The Clorox Company has a market cap of
7.73B which is considerably higher than the industry average of 1.38B.
However, because Clorox’ main product focus is in the cleaning products
industry, they’re market cap is smaller than their large conglomerate
competitors; who produce a wide range of different products across
several industries. For example, J&J produces medical devices and
prescription products in addition to their cleaning products that directly
compete with Clorox. Despite the smaller firm size however Clorox’ stock
price has consistently outperformed its competitors and the S&P 500 for
the past five years.
http://www.moneycentral.msn.com
With its expansion in international markets, Clorox has been growing
at a fairly constant rate. Again, with respect to some of its larger
competitors, Clorox’ sales growth appears small. However, this is to be
expected due to the nature and size of the competition. As shown in the
table below, Clorox has been growing sales while keeping their total asset
base relatively constant. This is a promising indication because it shows
that Clorox has the ability to increase sales through improved utilization of
assets.
Total Assets, Net Sales, and Comparable Sales Growth
2003 2004 2005 2006 2007
Total
Assets*
3,652 3,834 3,617 3,616 3,666
Net Sales* 3,986 4,162 4,388 2,685 2,756
Sales
Growth
-1.85% 4.42% 5.43% 5.83% 4.37%
*In millions
Industry Overview
The cleaning products industry is a highly competitive industry. In
the input side of production a handful of Clorox’ suppliers have leverage
against the Company in determining prices of raw materials.
Conversely, in the output side of production the trend in the industry is to
sell through mass merchandisers, who constitute the majority of sales, with
the remainder being sold through warehouse clubs, grocery stores and
other types of retail intermediaries. Due to the massive size of mass
merchandisers and the percentage of net sales they comprise, they have
the power to control price to a great extent and therefore exercise
bargaining power over the industry as well.
Research and development is another key factor to consider in the
cleaning products industry. Firms must devote significant resources and
attention to R&D to develop new products as well as improving existing
products and the processes that create them. Clorox incurred expenses of
$108M for R&D in 2007 alone.
Environmental matters, is another key point that requires
consideration. Due to the nature of the industry, firms have to dispose of
and handle many materials considered to be hazardous. The disposal
process of these hazardous materials in particular poses potential risk and
liability. Third party disposal sites in addition to current and former
operating facilities could become contaminated and become the focus of
environmental remediation.
Five Forces Model
The Five Forces Model is an evaluation tool used by analysts to
classify the structure within an industry and the areas of profitability within
it. The Five Forces Model starts by evaluating the competition within the
industry and does this by examining the rivalry among existing firms, the
threat of new entrants, and the threat of substitute products. Next, the
Five Forces Model examines the relative bargaining power of customers
and suppliers. Overall, the Five Forces Model is a measurement of potential
problems and profitability for the firms in an industry. The table below
summarizes the results of the Five Forces Model for the cleaning products
industry.
Rivalry Among Existing Firms High
Threat of New Entrants Low
Threat of Substitute Products Low
Bargaining Power of Customers High
Bargaining Power of Suppliers Moderate
Rivalry Among Existing Firms
Today, profitability in most industries is influenced by the rivalry
among existing firms within a firm’s industry. This rivalry can be split up
into two categories, Cost Leadership and Differentiation. Firms that
compete on costs stress: economies of scale, efficient production, simpler
product designs, lower input costs, low-cost distribution, tight cost control
systems and little expenditures in research and development. These firms
strive to make their product cheaply and efficiently while maintaining a
certain quality standard. Therefore, this strategy attracts customers with
low prices and good value.
Differentiation, on the other hand incorporates: superior product
quality, variety and customer service, flexible delivery, large investments in
research and development and brand image, as well as a strong focus on
creativity and innovation. These firms have more specialized goods, which
means they set the industry competition and price levels.
In the cleaning products market there is a mixture of these two
competitive advantages. Companies within this industry want to make their
product cheaply without sacrificing quality while also competing on price.
Furthermore, this industry requires that firms compete for shelf space in
retail stores. Firms do this by investing in brand image and producing a
superior product. When a firm achieves these milestones they can achieve
a competitive edge over their competition.
Industry Growth Rate
Understand the industry growth rate enables us to see the level of
intensity in regard to competition. This growth rate shows us if a company
is rapidly growing or stagnant. In a rapidly growing industry, companies
do not need to take market share from others to grow. Instead, these
companies will need to find ways to appeal to new customers that are
entering the market. On the contrary, if an industry is growing at a slow
rate, or not at all, the only way existing firms in that market can grow is by
stealing market share from other firms. In this situation it is very common
for companies to have price wars in the competition for customers. In the
figure below you can see that this industry is growing, but at a slow rate.
We feel that this industry is growing due to the high degree of competition
at home and abroad. This low growth indicates that these companies will
need to fight for market share and attempt to steal market share from
other while maintaining a competitive edge in the market.
*Percentages developed by comparing sales from the 10-K statements of Colgate-Palmolive, Procter &
Gamble, Johnson & Johnson, and Clorox.
Industry Concentration
Industry concentration is a measure of how many firms there are
actively competing with each other in a given industry. Concentration plays
a key role in driving price and competition. If an industry is said to be
highly concentrated, this means there are few firms competing amongst
each other. As a result of less competition there is less need to compete for
market share. Differentiated markets tend to be highly concentrated
however the cleaning products industry is a cost driven, less concentrated
industry. As a result the incentive to compete for market share is high and
there are many competitors.
The graph below shows there are some dominant firms in the
cleaning products industry, but these numbers are skewed. The operations
of these large conglomerates go beyond the scope of cleaning products
due to the nature of their business. However, all companies within the
industry are forced to be highly competitive.
*Percentages computed by finding what percent net sales of one period are of the total industries sales
of the same period. Numbers were derived from the 10-K’s of Clorox, Johnson & Johnson, Procter &
Gamble, and Colgate-Palmolive.
Degree of Differentiation
Firms that are highly differentiated enjoy the benefit of setting
themselves apart from the competition and charge a premium for that
recognition. In the cleaning products industry however firms tend to have a
low degree of differentiation and therefore are forced to compete on price.
When the products or services in an industry are similar, customers
are more inclined to switch from one competitor to the next purely based
on price. This will cause price wars that ultimately hurt the industry. Firms
can’t afford to lower their prices on a continuous basis and maintain proper
levels of working capital. Instead firms strive for differentiation based on
quality therefore there is a minimal amount of differentiation in the
cleaning products industry. As a result, customers are less inclined to
switch and may be more willing to pay a higher price.
Within the cleaning products market, firms must continue to compete
for shelf space in retail stores and create innovative products that will meet
the changing world of customer needs. With the growing desire for
environment friendly goods and technological advances, firms must be
willing and able to adapt to these changes.
Switching Costs
Switching costs are the cost relevant to a firm in an industry that
wants to rethink the direction of their company and put their resources into
a completely different industry. If switching costs are high in an industry,
firms will be less willing and able to change industries. This is because a
firm is already established and has no choice but to stay in that industry.
Take the airline industry for example; it is near impossible to find another
use for an airplane. This market has high switching costs; therefore, these
companies have no choice but to stay in that industry. When a market has
low switching costs, firms have the ability to come and go as they please.
This creates an incentive for firms to compete with their prices to keep
their share of the market. The cleaning products industry experiences high
switching costs because of the extent and complexity of their many
products. The costs allocated with switching to a completely new market
would be devastating to a firm in this industry. Too much of their money is
invested in manufacturing and distribution facilities, for example, to switch
from this industry to another.
Economies of Scale
Economies of scale result when the operations of a firm are very
large in scope. Larger companies are more established in the industry,
making it easier to bargain with suppliers and keep their costs low. This
ability makes it easy for large firms to charge lower prices for their
products, which in turn, makes it easier for these firms to attract
customers. In the cleaning products market, it takes huge amounts of
resources and capital to get started. In order to maintain a high level of
success in the cleaning products industry, firms strive for economies of
scale. The chart below shows that JNJ and P&G are the largest firms in the
cleaning products industry. Consequently, they are also the leaders within
the segment.
Total Assets
2003 2004 2005 2006 2007
CLX 3,562 3,834 3,617 3,616 3,666
JNJ 48,263 53,317 58,025 70,556 29,945
PG 43,706 57,048 61,527 135,695 138,014
CL 7,479 8,673 8,507 9,138 10,112
*In millions
Learning Economies
Learning economies are the basic idea of whether you have to be
“smart” to be in this industry. The implication is whether a firm needs
patents, copyrights, or legal entities of that nature. This is basically the
first mover advantage. When a firm has this advantage, they set the
standard for the industry; they could possible be the first firm to invent a
new product or come up with a new and more efficient product that needs
patenting. These companies spend a lot of money on research and
development to gain a competitive edge in their industry. The cleaning
products market is not necessarily experiencing this however this industry
spends a good amount of money trying to improve existing products.
Fixed-Variable Costs
Fixed to variable costs are key drivers in how a firm decides to price
their product and the quantity sold. Fixed costs consist of things like rent
for manufacturing facilities and overhead. When fixed costs are high, firms
need to reduce their prices to totally utilize installed capacity. Variable
costs on the other hand consist of costs for raw materials and supplies, for
example. Variable costs and fixed costs can be high simultaneously, being
that the raw materials used become expensive to purchase for whatever
reason. The cleaning products industry, typically, has high fixed costs.
Companies in the cleaning products industry typically have high fixed cost
due to the necessity for manufacturing and distribution facilities in the
United States and abroad. Manufacturing facilities drive up the fixed costs
for a firm tremendously. Currently, variable costs are on the rise in the
cleaning products industry. This industry has been experiencing a rise in
the costs of raw materials such as, resin, chlor-alkali, linerboard, soybean
oil, and other chemicals for example. However, keeping control over fixed
costs and finding better alternatives, with regard to variable costs, will
enable firms to maintain their profitability.
Excess Capacity
Excess capacity within a firm is when that firm has too much supply
and not enough demand from customers. If this industry has too much
capacity, firms are almost forced to cut prices to fill capacity. This process
obtains revenue that most likely would not be coming in if the prices were
at their original state. When a firm is operating at full capacity they can
charge the same or even higher prices because they don’t really care about
losing a few customers. However, a company with excess capacity has to
cut prices to keep customers. The threat of losing customers when there is
excess capacity is a significant problem.
In the cleaning products industry the majority of firms utilize their
property, plant, and equipment to a healthy extent. This is shown in line
graph below. When the line is upward sloping, the graph indicates that a
firm is efficiently utilizing its property, plant, and equipment efficiently.
There are differing reasons why a firm would not utilize its property, plant,
and equipment efficiently. For example, the firm might have a couple of
manufacturing facilities that are shut down and not producing anything.
This sort of activity can strongly harm a firm because they are still paying
the fixed costs related to those facilities even though they are not
generating revenue from production.
Exit Barriers
Exit barriers are any obstacles that prevent a company from leaving
the industry in which they are competing. Good examples of exit barriers
can be government regulations, a high fixed asset to variable cost ratio,
and a specialized asset or product. In the cleaning products industry there
aren’t as many exit barriers, however firms will be very unlikely to exit the
market because of the large amount of money and time that has already
been spent on their operations. It would be too costly to the firm to exit
the industry.
Conclusion
The rivalry among existing firms in the cleaning products industry is
intense as a result of the key factors discussed above. The industry growth
within the cleaning products industry is slow indicating a high level of
competition. At a glance the level of concentration in this industry would
not support this level competition. However, these numbers are skewed
because incorporated in the numbers are large conglomerates whose
operations extend beyond the scope of cleaning products. In an attempt to
distinguish products in this industry firms implement a moderate level of
differentiation, by doing so firms can avoid some level of customer
switching. However, the cleaning products industry is predominantly cost
driven. Furthermore, economies of scale is a crucial factor in this industry,
it gives firms the ability to produce more efficiently and insulates firms in
the event of excess capacity.
Threat of New Entrants
A new business trying to make its way into an existing industry can
be a difficult task. The business has many obstacles to overcome, such as
competing against larger, more distinguished companies. There are many
factors that affect a new business entering a market, such as scale
economies, first mover advantage, distribution access, relationships, and
some legal barriers. In the cleaning products industry, new entrants will
have a very slim chance of survival competing with the larger and more
distinguished companies. For example, larger companies with brand
recognition are more likely to get better product placement on store
shelves. Furthermore, the amount of start up capital required in the
cleaning products industry is extensive.
Economies of Scale
Due to the costs of beginning a business in the household cleaner
industry and the highly competitive nature of the industry, a new small
company would see many problems. In the household cleaner industry,
bigger is certainly better. The industry is dominated by larger companies
who already have shelf space at super-centers, such as Wal-Mart, and who
have provided consumers with their products for many years and have a
strong sense of brand recognition and loyalty. There are a few smaller
local companies who fare somewhat decently in the industry in their local
geographical areas, but it would be extremely difficult for an up and
coming business to generate all the capital needed to distinguish
themselves to the consumer and separate their products from the products
already in the market. The costs to produce and package a product line
would be very expensive, and a small company would have trouble
competing with the prices of the larger companies’ products. Due to the
highly competitive nature of the industry, it would very extremely difficult,
but attainable, for a small up and coming business to gain market power.
Total Assets
2003 2004 2005 2006 2007
CLX 3,562 3,834 3,617 3,616 3,666
JNJ 48,263 53,317 58,025 70,556 29,945
PG 43,706 57,048 61,527 135,695 138,014
CL 7,479 8,673 8,507 9,138 10,112
*In millions
First Mover Advantage
A company that is the first to introduce a new product in its industry
certainly has an advantage in the market. Usually the introduction of new
products in this industry means creating a new product that is more
effective and easier to use for the consumer. For a new company,
developing quality products and convincing consumers to change from
other more distinguished products is a difficult task.
Larger companies who have a lot of market share and have been
spending time and money in research and development share an
advantage over smaller newer companies. To illustrate this point, take into
consideration the head start in working capital and research and
development these larger firms enjoy. Also, being a larger more well
established company allows firms to capitalize on their brand recognition.
For example, customers are more likely to buy products they know and
trust rather than newer, less recognized brands.
Furthermore, since most of the products in the cleaning products
industry are made of chemicals that are readily available to the firms in this
industry, new products are duplicated often. So even if a new company
develops a new product, expect the larger companies to come out with
something almost identical.
Distribution Access and Relationships
Having great relationships with the distributors and suppliers of your
product is very important in any line of business. In the cleaning products
industry, the main customers are super-centers such as Wal-Mart, but
smaller stores also purchase products from the producers. They then sell
the products to the consumers. Convincing popular stores to purchase
your product is extremely important, and maintaining a friendly relationship
with them is even more important. Properly managing the relationships
between the company and their distributors and suppliers is crucial to
running the business efficiently and profitably.
A recent trend in this industry is to set up distribution centers globally
in addition to the domestic distribution centers. This allows companies in
the industry to more effectively distribute their products in emerging global
markets such as India and South America.
Legal Barriers
Legal barriers can create an even tougher challenge to new
businesses entering the industry. The industry has many patents, license
agreements, and government regulations that can prevent a new business
from being successful. Although many companies already have their
products patented and trademarked, it still is possible to develop
something new. The household cleaner industry has many regulations as
to what goes into their products, and specific ways of how to label the
ingredients correctly. There are also many regulations that are put in place
to deter companies from polluting the environment, so new companies will
have to be very careful to abide by the laws in order to get their products
on the shelf.
Conclusion
The cleaning products industry has a low to medium threat of new
entrants in the market. The extent to which existing companies capitalize
on economies of scale and experience is a major determinant for new
entrants. Also, the industry is highly regulated by many areas of the
government and confiding with the regulations set forth can be very costly.
Furthermore, distinguished companies in the industry have the major
competitive advantage of brand recognition and brand loyalty. Advantages
such as these make it extremely difficult for new business to compete with
prices and be efficient and successful. New companies face hard times
finding shelf space at larger stores due to the relationships already
established by the dominant companies in the industry. Therefore, the
threat of new entrants is very low considering all the obstacles that stand
in the way. Although prices are competitive in this industry, the threat of
new entrants is minimal and poses no material price competition.
Threat of Substitute Products
In the cleaning products industry, a substitute product can be
described as any product that has the same cleaning function as another
existing product. In the cleaning products industry the amount of
substitute products are abundant. Therefore, firms rely on brand
recognition and are constantly working to develop better technologies for
existing products.
The threat of substitute products is always a major concern to
companies in the cleaning products industry. Losing shelf space to a
competitor can severely damage a firm’s profits, while helping boost their
competitor’s profits. There are many factors that can influence consumers
to switch to another product, for example relative price and performance
and the buyers’ willingness to switch.
Relative Price and Performance
The relative price and performance of a product will be a major factor
in determining if there will be a substitute. Price can be thought of as what
the consumer values the product at. Generally in the cleaning products
industry, brand names are priced a little higher. This is because consumers
have a higher perception of value for name brand products. However, if
the consumer believes that a less expensive product can do the same thing
the more expensive product can, substitution is probable.
Due to the highly competitive nature of the industry and the
continuous threats of substitute goods, firms spend a lot of time and
money in advertising and research and development to maintain a
competitive advantage. Many firms believe that advertising is a huge factor
for success and therefore spend a significant part of their resources on
trying to appeal to the consumers at the retail and individual levels. In the
cleaning products industry research and development is the key to coming
out with superior products that perform better for a lower price.
Firms in the cleaning products industry believe that the more the
consumer is exposed to their products, the more willing they are to buy
them, and if the product performs well and sells for a competitive price,
the more likely the consumer is to stick with their product.
Buyer’s Willingness to Switch
Another crucial factor of the threat of substitutes is the buyer’s
willingness to switch. Generally in the household cleaner industry, the
larger and more distinguished companies have good relationships with their
buyers. The companies in this industry work very hard to maintain good
working relationships with retail stores and super-centers. The retail stores
and super-centers have been carrying the larger companies’ goods for a
long time, and know that the value of the brand’s name and image will
help them make higher profits. Therefore, since the companies have a
good buyer/seller relationship, retail stores are usually very reluctant to
switch to another good.
Conclusion
Due to the high competition in the cleaning products industry as well
as first mover advantage and economies of scale, the threat of substitute
products is only moderate. Consumers at the retail store level are very
reluctant to switch products however there is always the looming threat
that a competing firm may come out with a superior product for a lower
cost. As long as the dominant firms in the industry continue to advertise
their products and brand recognition while continuing to produce quality
goods, the threat of substitutes in this industry will stay low. As a result
competition from new firms is marginal however the competition among
existing firms remains intense.
Bargaining Power of Customers
When measuring the power of customers, price sensitivity and
relative bargaining power are the two main points of interest. Price
sensitivity indicates how much customers are willing to negotiate price and
relative bargaining power measures the buyer’s ability to bid the price
down. For the cleaning products industry profitability and buyer bargaining
power share an inverse relationship. The customers in this industry are the
household consumers, and their willingness to switch is relatively high. As a
result they maintain a relatively high level of bargaining power and to an
extent dictate prices downward.
Price Sensitivity
In the cleaning products industry there is a high level of competition.
Firms not only have to compete against nationally advertised brands but
also with private label brands and generic non-branded products. In order
to set themselves apart, firms rely on brand recognition, quality, and
performance. However, due to the nature of the industry, products are still
price sensitive.
Relative Bargaining Power
Firms in the cleaning products industry sell to a thin customer base
comprised of mass merchandisers. For example, Wal-Mart is a massive
buyer for firms in this industry. It is not uncommon for such a large buyer
like Wal-Mart to comprise a substantial amount of sales for a given
company.
Furthermore, it is not uncommon for a firms business in the cleaning
products industry to be based primarily upon individual sales. This means
that in the industry, firms typically do not enter into long-term sales
contracts. This means that a firm’s customer base can take their business
elsewhere at any time and there is no hedge against this. Therefore, in the
cleaning products industry it is common for a firm’s best customers to have
a great deal of leverage over price.
Conclusion
There are two key factors that warrant careful consideration when
determining buyer bargaining power. Price sensitivity is a measure of the
buyer’s willingness to bargain on price. Whereas relative bargaining power
determines the extent to which the buyer can bid the price down. In the
cleaning products industry, firms manufacture price sensitive products that
are bid down by their primary customers. This buyer bargaining power
creates problems for the firms because they are then forced to differentiate
in an attempt to capture extra gains.
Bargaining Power of Suppliers
The degree of bargaining power a firm’s supplier maintains plays a
key role in a firm’s profitability. If the supplier has a high degree of power,
he or she can dictate price and cost. However, if the firm has a high
degree of power over its supplier, the firm can drive prices down as well as
well as other special requests such a speedy delivery.
Price Sensitivity
In the cleaning products industry firms have a high demand for raw
materials such as chemicals for use in production. These raw materials are
abundant and currently there are several sources from which these goods
are obtainable. A sufficient number of suppliers imply that the buyer’s
switching cost are low and therefore drives competition among suppliers.
However, there are areas of concern such as when firms are forced
to rely on a limited number of suppliers or even worse a sole supplier. If
firms within the industry cant contract the quantity and quality levels
needed from the se suppliers to continue production their bottom line could
be adversely affected. To hedge against this risk firms generally use supply
and forward-purchase contracts. This helps ensure the availability of raw
materials however overall price sensitivity in regard to the bargaining
power of suppliers is mixed.
Relative Bargaining Power
In the cleaning products industry, the relative bargaining power is
mixed as well, depending on the supplier. Sole suppliers and suppliers from
which there are a limited number to choose from for a particular product
will obviously have more leverage against firms. However, if the supplier is
one of the many others from which there are sufficient numbers to choose
from they will not share the same advantage. This is because their great
numbers and homogenous products force competition between them.
Conclusion
Bargaining power of suppliers in the cleaning products industry is
mixed. Firms have no trouble obtaining most of their raw materials at
competitive prices. However, firms do sacrifice bargaining power when
they have to buy materials from sole suppliers or when they have to
choose from a limited selection of suppliers.
Value Creation Analysis
There are two different kinds of competitive strategies a company
may choose to position itself within an industry, cost leadership and
differentiation. The cost leadership competitive strategy includes
economies of scale, efficient production, low input costs, simpler product
designs, low-cost distribution, little research and development and
advertising, and a tight cost control system. Companies utilizing this
strategy want to minimize as much cost as possible in able to sell there
products at a lower price than their competitors. By doing this they can
earn higher profits. On the opposite end of the spectrum is the
differentiation competitive strategy, which includes superior product quality
and variety, superior customer service, flexible delivery, investment in
brand image and research and development, and a focus on creativity and
innovation. Companies using this competitive strategy try to set their
products apart from their competitors by adding a perceived value to their
products over their competitor’s products. This allows them to receive a
premium for their product or service.
In the cleaning products industry, as well as many other industries,
companies use a combination of these competitive strategies to form their
business strategies. The companies in the cleaning products industry rely
mostly on the differentiation competitive strategy. They compete on
product performance, brand recognition, product variety, and invest heavily
in research and development. According to Colgate-Palmolive, “Product
quality and innovation, brand recognition, marketing capability and
acceptance of new products largely determine success in the company’s
business segments.” (Colgate-Palmolive 2008 10-k) The companies in the
cleaning products industry also use some aspects of the cost leadership
competitive strategy. They must compete on price, have efficient
production, and have economies of scale and scope.
Economies of Scale and Scope
Companies in the cleaning products industry must also compete on
price, which is a cost leadership competitive strategy. With so many
different brands of cleaning products which are very similar, price becomes
an important factor to the consumer. Another reason price is important is
because of the recent growth of generic brands that sell at a discount to
branded products. For companies to keep their loyal customers and gain
new ones they must compete on price.
To enable companies in the cleaning products industry to compete on
price they must have efficient production and economies of scale and
scope. By producing their products efficiently and on a large scale
companies in the industry can sale their products at a lower more
competitive price. Proctor & Gamble says they “improve profit margin by
driving out costs and complexities that do not add value for consumers…by
leveraging P&G’s significant manufacturing and purchasing scale…and by
constantly improving organizational effectiveness and productivity.”
(Proctor & Gamble 2008 10-k)
Research and Development
To ensure product performance and continue adding a variety of
products to their product lines companies in the cleaning products must
invest in research and development, which is another important factor in
this industry. According to Clorox, “The Company’s future performance
and growth depends on its ability to successfully develop and introduce
new products and line extensions.” (Clorox, Co. 2008 10-k) Colgate-
Palmolive put it this way, “our growth depends on the continued success of
existing products as well as the successful development and introduction of
new products and line extensions.” (Colgate-Palmolive 2008 10-k)
Companies in this industry spend considerable amounts of money on
research and development, below is a chart showing the research and
development expenditures for Clorox, Colgate-Palmolive, and Proctor &
Gamble.
As shown above, for a company to stay competitive in this industry it
must invest in research and development to create new and innovative
products and to ensure the continued performance of its existing products.
Superior Product Quality and Variety
Since there are so many different products in the cleaning products
industry product performance is very important. Customers want a
product that works and if a companies product doesn’t perform well
consumers can easily switch to a competitor’s product that does. For a
company to be competitive in this industry they must maintain superior
product performance.
Product variety is also important in the cleaning products industry.
The variety of products in the cleaning industry include: laundry additives
such as gels, bleaches, stain-removers, and color-safe bleaches , along
with cleaning products like disinfecting sprays and wipes, toilet-bowl
cleaners and other bathroom cleaners, glass and surface cleaners, carpet
cleaners, drain openers, cleaning clothes, steel-wool soap pads, and
scrubber sponges. With so many different products being sold in the
cleaning products industry a company must manufacture a large variety of
consumer products to keep a competitive edge.
Investment in Brand Image
Brand recognition is also very important in the cleaning products
industry. Companies in the highly competitive industry must keep strong
brand awareness for their products in order to retain there position in the
industry. They do this by investing in marketing and advertising. Proctor
& Gamble says, “We market our products with advertising, promotions, and
other vehicles to build awareness for our brands… We believe this
combination provides the most efficient method of marketing for these
types of products.” (Proctor & Gamble 2008 10-k) Colgate-Palmolive
states that their ability to compete depends on the strength of their
brands. (Colgate-Palmolive 2008 10-k) In the cleaning products industry
companies must invest in brand image to stay competitive.
Conclusion
In conclusion, for companies in the highly competitive cleaning
products industry to be successful they must combine aspects of both the
differentiation and cost leadership competitive strategies. They must have
superior product performance and variety. To accomplish this, companies
must invest heavily in research and development. They also must invest in
brand recognition to keep and improve their brand awareness. Companies
in this industry must also compete on price to stay competitive. They must
use efficient production and economies of scale and scope to keep their
prices low. These key success factors allow companies in the cleaning
products industry to stay competitive and value to their firms.
Competitive Advantage Analysis
To compete in the cleaning products industry Clorox must utilize the
key success factors described above. They must be able to implement
both differential and cost leadership competitive strategies. These
strategies include product performance and variety, investment in brand
image, and brand recognition. Clorox also needs to compete on price,
have efficient production, and have economies of scale and scope. Clorox
states that “the company’s products compete on product performance,
brand recognition, price, quality or other benefits to consumers.” (Clorox
2008 10-k)
Superior Product Quality and Variety
It is very important in the highly competitive industry for Clorox’s
products to perform well. Since there is such a wide array of cleaning
products to choose from including cheaper generic brands, Clorox must
make sure their products have top performance. The main way they
ensure this is by investing in research and development to keep the
products they already manufacture in top performance. The company paid
$108 million in research and development costs in 2007. They use part of
this research and development to maintain and improve their existing
product line.
Product variety is another important success factor that Clorox must
use to stay ahead of their competition. Research and development also
plays a key role in this competitive strategy. The money not spent to
maintain existing product lines is used to develop new products. Clorox
“devotes significant resources and attention to product development,
process technology and researching consumer insights to develop
consumer-preferred products with innovative and distinctive features.”
(Clorox 2008 10-k) Currently, Clorox produces a wide variety of cleaning
products including: laundry additives, disinfecting and sanitizing sprays
and wipes, several types of bathroom cleaners, drain openers, scrubbing
pads, carpet cleaners, and glass and surface cleaners. They also produce
water filtration systems.
Superior Customer Service and Flexible Delivery
Clorox must also compete on price in this highly competitive industry.
With the recent popularity in cheaper generic brands it is very important
for Clorox to keep their prices as low as possible to stay competitive. One
way Clorox keeps its prices low is by reducing the costs of its raw
materials. They do this by using long-term commodity purchase contracts
and commodity derivative contracts. Swaps, futures, forward, and option
contracts are the main derivative contracts that Clorox uses. By using
these contracts Clorox is able to save money on their raw materials and
pass these savings on to their customers. They also use different
advertising and promotions to keep their prices competitive. These include
shelf-price reductions, sales, and in-store promotions. They also keep
prices low by having efficient production and economies of scale and
scope.
Efficient production and economies of scale and scope are both
important for Clorox. To stay competitive in the cleaning products industry
they must use efficient production techniques to cut costs and receive
higher profits. One way they are doing this is by simplifying their supply
chain. In late 2007, Clorox decided to close some of their domestic and
international manufacturing plants. They will redistribute the work from
these manufacturing plants to plants they still own and to third-party
manufacturers. By doing this they will reduce operating costs and optimize
their available capacity. According to Clorox this restructuring will save
them $23 to $24 million per year. (Clorox 2008 10-k) Economies of scale
and scope are also important for Clorox to stay competitive. They need to
manufacture a variety of products on a large scale to keep up with other
companies in the industry. The chart below shows the total assets of
Clorox and some of its competitors to illustrate the importance of
economies of scale and scope in this industry.
Proctor & Gamble has substantially more total assets because they are
involved in the manufacturing of many more products outside of the
cleaning products industry. Colgate-Palmolive is also involved in the
manufacture of more products other than the cleaning products industry,
mainly personal hygiene products. Even though there are clear differences
in the total assets of the three companies it is evident how large these
companies must be to stay competitive.
Research and Development
As shown below, one of the key strategies that keep Clorox
competitive is its investment in research and development. This
expenditure allows the company to continually improve its product
performance and introduce a wide variety of products for its consumers.
The graph below shows the research and development costs for the last
five years.
As the graph shows, Clorox spends considerable amounts of money
on its research and development. They spent 2.2%, 2.1%, and 2% of
their net sales on advertising in 2007, 2006, and 2005, respectively.
Investment in Brand Image
Clorox must also invest heavily in brand recognition to stay
competitive in the cleaning product industry. Because there are so many
different brands of products in this industry, including cheaper generic
brands, Clorox must continually invest in brand recognition to gain new
consumers and keep existing ones. The main way they do this is by
marketing and advertising. According to Clorox, “a newly introduced
consumer product (whether improved or newly developed) usually
encounters intense competition, requiring substantial expenditures for
advertising, sales promotion, and trade merchandising support.” (Clorox
2008 10-k) Even after one of their products is popular among consumers,
they must continue advertise and market the product to keep its market
position. Since brand recognition is so important in this industry, Clorox
spends a considerable amount of money on marketing and advertising.
The chart below illustrates this point.
Conclusion
In conclusion, there are several key success factors that Clorox must
take into account to compete in this industry. The differentiation
competitive strategies they need to implement are product performance
and variety, investment in research and development, and brand
recognition. The cost leadership competitive strategies that Clorox must
use are competitive pricing, efficient production, and economies of scale
and scope. Clorox does take these key success factors seriously and has
implemented programs and business strategies to succeed in the cleaning
products industry.
Formal Accounting Analysis
Accounting analysis is very important in a business valuation. The
reason for an accounting analysis is to determine how well a company’s
financial disclosure actually reflects its business activities. Because GAAP
allows some flexibility in its disclosure, managers may be able to distort the
real effects of some of their business activities. This flexibility can be very
beneficial because it allows managers to more accurately describe the
nature of their business. On the other hand, some managers can abuse
this flexibility to make their overall earnings seem to be lower or higher
than reality. This is the reason accounting analysis is very important in any
business valuation. There are six steps in an accounting analysis,
including: identifying principal accounting policies, assessing accounting
flexibility, evaluating accounting strategy, evaluating the quality of
disclosure, identifying potential red flags, and undoing accounting
distortions.
The first step in accounting analysis is identifying key accounting
policies. The key accounting policies are directly tied to the key success
factors that a company must utilize to be successful in an industry. It is
important to evaluate how well a company discloses and measures its key
success factors through its accounting policies. Other key accounting
policies that need to be reviewed are items that may significantly alter a
company’s financial statements. These include items like how a company
treats leases, whether they are capital or operating leases, how they treat
goodwill, and their pension and retirement plans. The second step is to
assess the degree of accounting flexibility. This also relates to the key
success factors of a company, and must be evaluated to determine how
much flexibility a company has in disclosing business activities related to
these key success factors. The third step is to evaluate accounting
strategy. Evaluating the accounting strategy of a firm allows analyst to
determine if a company uses conservative or aggressive accounting
strategies. Conservative accounting strategies can understate the actual
net income of a company while aggressive accounting strategies tend to
overstate a companies net income. After accounting strategy has been
evaluated the next step is to evaluate the quality of disclosure. Manager’s
can make financial statements as transparent or nontransparent as they
wish, as long as they comply with GAAP standards. A more transparent
financial statement makes it easier for analyst to understand the reality of
a company’s financial statements. The fifth step of an accounting analysis
is to identify potential red flags. A red flag is something that may lead to
questionable accounting practices. These red flags must be further
examined to decide if they affect a company’s financial statements. The
last step is to undo accounting distortions. If during the accounting
analysis some of the company’s financial statements are determined to be
deceptive, they must be restated in this step to form a more accurate view
of the company’s business activities.
Key Accounting Policies
It is important to know the key success factors of a company to
determine their key accounting policies. The key success factors are the
strategies a company relies on to stay competitive. As stated above,
Clorox’s key success factors include brand recognition, investment in
research and development, product performance and variety, low prices,
efficient production and economies of scale and scope. From these key
success factors and how they are treated, the key accounting policies can
be found. Key accounting policies also include how a company treats
significant asset or liability items, and if these items materially affect how
an outside analyst views the company.
Research and Development
Research and development is very important in the cleaning products
industry. Because of the high amount of competition in the industry,
companies must continuously add to and reinvent their products. Clorox’s
10-k states, “The Company’s future performance and growth depends on
its ability to successfully develop and introduce new products and line
extensions.” (Clorox, Co. 2007 10-K) Their research and development
costs increased 9% in 2007 from 2006. Although these costs do have a
future benefit, GAAP requires that they be expensed and cannot be
capitalized as an asset. Clorox expenses research and development costs
in the period they are incurred, therefore following the rules of GAAP.
Goodwill
Because brand recognition is so important in the cleaning products
industry, how goodwill is treated can be very important to an analyst.
Clorox treats and reviews the value of its goodwill according to SFAS No.
142, “Goodwill and Other Intangible Assets.” They use a discounted cash
flow model to assess the value of their goodwill. This model involves the
managers of Clorox estimating many of the inputs including expense
growth rates, foreign-exchange rates, inflation, discount rates, and other
variables. Like other companies in the cleaning products industry, Clorox
tests its goodwill every year. They may also test for impairment of
goodwill if certain events indicate that impairment may have occurred.
These events include bad economic conditions, changes in technology or
competitive activities, losing important employees, and government
intervention. There were no impairments in 2007, and Clorox’s 10-k shows
that they have $855 million in goodwill. A table of Clorox’s goodwill broken
down by segments is shown below. Goodwill is 23% of total assets, which
makes it a significant percentage of Clorox’s total assets.
Goodwill by Segment Household Group - Specialty North America Group International Corporate Total
2003 $ 125 $ 381 $ 155 $ 69 $ 730
2004 $ 421 $ 83 $ 169 $ 69 $ 742
2005 $ 426 $ 68 $ 180 $ 69 $ 743
2006 $ 445 $ 68 $ 185 $ 46 $ 744
2007 $ 524 $ 79 $ 252 $ - $ 855 *In millions (Clorox 2008 10-k)
Operating leases
Another key accounting policy that managers can use may cause
distortions on their balance sheet, is the use of operating leases. By using
operating leases instead of capital leases manager’s can leave substantial
amounts of leases off their balance sheets. This in turn leaves their
liabilities understated. If a company is leasing an asset for its entire useful
life it should treat it as a capital lease and state the lease on its balance
sheet. Clorox owns most of its facilities including 46 manufacturing
facilities in the United States and Internationally. They also own their
general offices and technical and data centers. They do use some
operating leases including 7 regional distribution centers, 2 research and
development centers, and an engineering center. Clorox also uses
operating leases for its information technology equipment and
transportation equipment. Below is a table showing Clorox’s future lease
payments. Their total future minimum rental payments are not really a
significant size relative to their total liabilities. These rental payments only
account for 6.8% of their total liabilities.
Operating Leases Future Minimum
Year Rental Payments2008 $ 26 2009 $ 23 2010 $ 21 2011 $ 16 2012 $ 14
Thereafter $ 41 Total $ 141 *In millions (Clorox 2008 10-k)
Operating leases are used throughout the cleaning products industry. The
graph below shows the operating leases of other companies in the
industry, with respect to Clorox.
(Clorox, Colgate-Palmolive, and Proctor & Gamble’s 2008 10-k)
Pension Plans
Employee benefit pension plans can also have an impact on a
company’s income statement. The reason pension plans are important is
because they require several estimates by managers in order to value
them. Estimates include healthcare costs, discount rates, growth rates,
and how long employees will work for a company, as well as, how long
they will use the planned benefits. Clorox recently adopted SFAS No. 158
“Employers’ Accounting for Defined Benefit Pension and Other Post
Retirement Plans.” (Clorox 2007 10-k) This standard, values a defined
benefit plan as the difference of the fair value of the defined benefit plan
assets and the plans future obligations. To find the future value of the plan
Clorox must estimate the rate of return and the discount rate. In 2007,
they used 8.25% for the rate of return and 6.25% for the discount rate.
According to Clorox’s 2007 10-k, “a decrease of 1% in the discount rate
would increase pension liability by approximately $50 million, and
potentially increase fiscal year 2008 pension expense by $4 million. A 1%
decrease in the long-term rate or return on plan assets would increase
future pension expense in fiscal ear 2008 by $3 million.” (Clorox 2007 10-
k) As you can see, it is very important for Clorox’s managers to use
accurate estimates for the rate of return and the discount rates of its
benefit plans. If the actual required rate of return differs from the
estimated rate of return used, Clorox states the difference as net periodic
benefit cost. To find the estimated rate of return for the benefit plans,
Clorox analyzes the history of the portfolio and reviews the returns of each
asset and finds a rate that is equal in proportion to the fund’s current asset
allocation. To find the estimated discount rate the company uses the
Moody’s Aa-rated long-term bond yield index. According to Clorox this
index is similar to the timing and cash flows of its own defined benefit
payments. (Clorox 2007 10-k) Below is a table showing Clorox’s estimated
discount rates and expected rates of return for the last three years.
The discount rates and expected return on Plan Assets for Clorox are
very reasonable numbers with regard to the industry. Colgate-Palmolive
has a discount rate of 6.5% in 2007, 5.8% in 2006, and a 5.5% in 2005.
Procter & Gamble has a discount rate of 5.5% in 2007, 5.2% in 2006, and
4.5% in 2005. Johnson & Johnson has a discount rate of 6.5% in 2007,
6% in 2006, and 5.755 in 2006. As you can see in the chart below, the
discount rates of Clorox and the industry are all steady around the 6%
range. Clorox has a drop in their discount rate in 2006, however it is
consistent with the rest of the firms in the industry.
The Expected Return on Plan Assets for Clorox is very steady with
the industry as well. Colgate-Palmolive has an expected return rate of 8%
in 2007, 8% in 2006, and 8% in 2005. Procter & Gamble has an expected
return rate of 7.2% in 2007, 7.3% in 2006, and 7.2% in 2005. Johnson &
Johnson has an expected return rate of 8.25% in 2007, 8% in 2006, and
8.25% in 2005. As you can see in the chart below, the expected return
rate for Clorox and the industry are steady around the 8% range. All of
the rates for Clorox and their competitors are reasonable relative to the
S&P 500 over the same time period.
Estimated Discount Rates and Expected Rates of Return for Employee Benefit Plans
2005 2006 2007 Discount Rate Range 5.50% - 6.50% 5.00% - 5.25% 5.50% - 6.25% Weighted Average 6.49% 5.01% 6.23% Expected Return on Plan Assets Range 6.50% - 8.25% 6.50% - 8.25% 6.50% - 8.25% Weighted Average 8.18% 8.18% 8.17%
(Clorox 2008 10-k)
Foreign Currency
Another important accounting policy for companies that have
business activity outside of the United States is how they deal with foreign
currency exchange risk. Business activities performed outside of the U.S.
result in earnings and expenses in the currency of the country where the
business activity takes place. Because foreign exchange rates are always
changing, a company who does business outside the U.S. must have some
method for managing foreign exchange rate risk. Clorox has net sales of
$870 million in foreign markets compared to $3977 million in domestic
markets, or about 18% of net sales. Because of this they must use some
form of foreign exchange rate risk.
To account for this risk Clorox uses foreign currency derivative
contracts in the form of foreign currency forward and options contracts. By
using these contracts Clorox is able to hedge against any unfavorable
changes in foreign exchange rates. Most of the company’s contracts are
with Canadian and Australian dollars. “A 10% increase or decrease of the
value of the U.S. dollar compared to the currencies that the company has
derivative contracts with would result in a loss or gain of $4 million.”
(Clorox 2007 10-k) This is reported as Other Income (expense) on the
income statement. “The company’s contracts are hedges for transactions
with notional balances and periods consistent with the related exposures
and do not constitute investments independent of the exposures.” (Clorox
2007 10-k) Since Clorox only enters into these contracts with creditworthy
institutions, they consider their counterparty’s credit risk low.
Clorox have three rules to decide if hedging is suitable. These rules
are “(a) the designation of the hedge to an underlying exposure, (b)
whether overall risk is being reduced, and (c) whether there is sufficient
correlation between the value of the derivative instrument and the
underlying obligation.” (Clorox 2007 10-k) To estimate the fair value of
their derivatives, Clorox uses quoted market prices and broker price
quotations. This fair value is how much the company would have to pay or
receive to cancel out the contract. In 2007, Clorox reported foreign
exchange contracts worth a notional value of $38 million; the fair value of
these contracts was negative $2 million.
Potential Accounting Flexibility
In the United States, the Financial Accounting Standards Board
(FASB) has been the key influencer in accounting standards. Through their
implementation of Generally Accepted Accounting Principles (GAAP), FASB
has increased uniformity in accounting practices. However, flexibility in
reporting is still needed so that corporate mangers can best reflect valuable
inside information in reported financial statements. This accounting
discretion is granted to mangers because of their intimate knowledge of
their firm’s businesses. It is important to remember however, that
managers have incentives to distort accounting numbers for a myriad of
reasons including: bonus compensation, stock option awards, tax
considerations, corporate control contest and stakeholder considerations.
“Therefore, the delegation of financial reporting decisions to managers has
both costs and benefits.” (Business Analysis Evaluations, Palepu & Healy)
Research and Development
In the cleaning products industry it is not uncommon to see large
investments in R&D. Since this industry is a commodity industry firms are
constantly seeking ways to improve existing products and find cheaper
ways to manufacture them.
Under their new Centennial Strategy, Clorox plans to grow sales 3-
5% annually. A key driver of the strategy is increased investment in R&D.
If Clorox could capitalize their investments in R&D the Company could
better utilize assets and increases profitability. However, GAAP has strict
accounting policies for reporting R&D that require firms to disclose R&D as
an expense. Therefore, there’s no real flexibility in reporting R&D.
Goodwill
Goodwill is an intangible asset that, during acquisition shows the
intrinsic value of a firm. Due to the difficulty of estimating goodwill,
managers have a good deal of flexibility in how they account for it in
intangible assets. Furthermore, GAAP states that goodwill cannot be
capitalized when created from within the firm. Therefore, the only way a
firm can recognize goodwill is through the acquisition of other companies.
Recently Clorox acquired bleach companies in Canada and Latin
America and has therefore been experiencing growth in goodwill. The
Company performs annual reviews of goodwill and other intangibles to
determine whether impairment is necessary. Thus far, Clorox has not
impaired any of the goodwill resulting from acquisitions. Some may view
this as a red flag however this practice is common within the industry.
Operating Leases
When recording lease commitments in the financial statements, a
great deal of discretion is delegated to top management. The two main
lease choices managers’ face is whether to report them as capital or
operating. In the cleaning products industry, operating leases seem to be
the standard procedure. However, by using operating leases firms can
avoid reporting large liabilities on their balance sheets and therefore
overstate their earnings.
Clorox uses operating leases but this is the normal practice in the
industry. If the Company decided to switch to capital leases however, they
would overstate their assets and liabilities. Therefore, analysts must
recognize the flexibility of disclosure when firms record leases in their
financial statements. Careful examination of this process could determine
whether or not a firm is under or over valuing its business.
Pension Plans
Pension plans are a firm’s obligations to provide future benefits to its
employees after they work for the Company. In order to value these
pension plans, managers must estimate future interest and growth rates.
However, these are man made estimations and are susceptible to error.
Managers can easily manipulate the expenses associated with pension
plans as well as the present value of their liabilities. For example,
overestimating future interest rates or underestimating future growth rates
of plan assets can decrease the present value of their liability.
Furthermore, the sensitivity involved in this estimation of future rates is
extremely high. Minute changes in the estimation of future rates can cause
pension liabilities to fluctuate in tens of millions of dollars.
As stated in their most recent 10-K, Clorox uses the Aa-rated long-
term bond yield index from Moody’s to annually determine the Company’s
discount rate. This is a good practice because those particular bond yields
index mirrors the timing and cash outflows of the Company’s defined
benefit plan.
Conclusion
Managers are delegated a great deal of flexibility when creating
financial reports. This concept is paramount in that it allows mangers to
clearly and accurately portray inside information to investors. However, this
comes at a price because managers have incentives to manipulate the real
numbers. Also, because these are people made estimations there is a high
potential for accidental error. These are the key reasons why analysts must
pay close consideration to the flexibility a firm utilizes while disclosing
information in their financial reports.
Accounting Strategy
The type of accounting strategy management chooses to use
ultimately impacts investors’ views of the company. Manipulation of
financial data can make the company look like they are in a better position
than they really are. In the U.S., there are sets of accounting procedures
that must be followed as set by the guidelines of the GAAP. For example,
when Clorox trades in foreign markets they don’t have to abide by GAAP. It
is important to determine if management accurately portrays a true view of
the company, domestically and internationally. Another good thing to do
when evaluating the company’s procedures is to benchmark, or compare,
their procedures to that of their major competitors. Clorox is in a highly
competitive market with many competitors. They all have a central goal to
keep costs as low as possible and to continue growth and advancement in
their industry. Also, the more information that a company provides on
their financial statements, the better view an investor will have of the
company’s position.
When a company reveals their financial information, they can do it
one of two ways, with a high degree of disclosure, or a low degree of
disclosure. Clorox is very good at disaggregating their information as well
as discussing how they came up with the numbers. A good example of
disaggregating their financial information is how they explain certain costs
such as advertising. Another example would be how much information was
provided in the footnotes describing how they differentiated activities that
went into the total cost shown on the income statement. Because Clorox
goes above and beyond to disclose valuable financial information in their
10-K, they have a high degree of disclosure. Clorox describes in great
detail how management decided to record certain items. Clorox does not
always use GAAP procedures in calculating data in foreign countries
however the Company goes through great length to disclose what they do
to the public. An investor can get enough information to make a wise
investment decision by reviewing the Clorox’s 10-K.
Benchmarking a firm’s financials with their competitors in their
industry is another great way to access they’re accounting strategies.
Clorox, as well as their other main competitors, are aggressive in reporting
earnings. Since being bigger in the household cleaner industry usually
means more success, companies are eager to report higher net earnings.
Also, Clorox reports their inventories at the lower of costs or markets, as
reported in their 10-K, which is another form of aggressive accounting
because it leads to higher earnings on their statements. The top
competitors also report their inventories in a similar fashion, which shows
how important cost leadership is to this industry.
Clorox reports their financial data much like their main competitors in
the industry. They have a high degree of disclosure, which can help gain
the trust and confidence of outside investors. Clorox uses aggressive
accounting strategies to report higher net earnings. This is shown over the
years by an overall continuous trend of higher net earnings year after year.
Clorox stays within the limitations of GAAP and uses the flexibility in
accounting procedures allowed to accurately portray their financial
situation.
Qualitative Disclosure
The quality of disclosure is an important part of evaluating a firms
accounting quality. Both the amount and quality of disclosure makes
evaluating a firm much easier for investors and analysts are better able to
get a true picture of a firm’s economic implication. These additional
disclosures allow managers to give people insight into the firm’s accounting
policies, company strategy, and performance. In a highly competitive
industry such as the cleaning products industry, managers are reluctant to
disclose too much information because of the potential loss of competitive
advantage. If the firms disclose too much of their key success factors,
other firms could read into that and utilize those strategies as well; this
action will erase their competitive advantage. In addition to protecting a
firm’s competitive advantage, a firm might be tempted to doctor up their
financial reports to make the firm look more profitable. Managers might
feel the pressure to do these things for many reasons such as, debt
covenants, meeting management compensation, and tax consideration.
Given these actions could potentially happen great care must be taken in
order to ensure the accuracy of the information that is being reported.
First, Clorox’s level of disclosure is very high. They go through a lot
to make sure that their financial statements are reader friendly and easy to
understand. For investors and analysts alike, this disclosure is key to
creating valuable information. With a myriad of descriptive exhibits and
footnotes reading the 10-K is an easier task. This helps analysts to
conclude what the underlying themes are throughout the 10-K.
Occasionally things may look misplaced or confusing, the footnotes and
exhibits as well as the management’s discussion and analysis portions of
the 10-K try to provided a better more detailed understanding. A good
example of this is the way Clorox describes their goodwill. The Company’s
goodwill increased a significant amount from 2006 to 2007 and is not
impaired, which can be a potential “red flag.” However, the footnotes
explain in detail that this increase is due to an acquisition of plants in
Canada and Latin America. It also explains that upper management meets
yearly to determine whether or not to impair their intangibles for that year.
Overall, the level of disclosure throughout the industry is relatively high.
Furthermore, Clorox has done a very good job of disaggregating their
financial data. This is also a great thing for analysts and inverters because
it makes the 10-K even more reader friendly. When a firm squeezes all of
its financial data together, analysts have trouble finding what business
activities coordinate with that particular data. For example, Clorox states
all of its financial statements first and then follows them up with the “Notes
to Consolidated Financial Statements” section. In this section of the 10-K,
every subheading is spelled out and explained thoroughly. It covers topics
like how key accounting policies are utilized and goodwill, trademarks, and
other intangibles.
Clorox also does a great job of reporting leases. Clorox owns most of
its facilities including 46 manufacturing facilities in the United States and
Internationally. They also own their general offices and technical and data
centers. However, they do use some operating leases including 7 regional
distribution centers, 2 research and development centers, and an
engineering center (Clorox 2007 10-K). In their 10-K, they go through
great detail in all the costs and future lease payments.
Over all, we find the disclosure of Clorox to be more than
appropriate. In most of the areas of the 10-K, the information is
straightforward and easy to understand. When it isn’t, the 10-K has
directions on where to find information that can clear up any
misunderstandings. Clorox’s above and beyond attitude in disclosure lends
credibility to the firm’s accounting quality.
Quantitative Disclosure
Quantitative Analysis is the “financial analysis technique that seeks to
understand behavior by using complex mathematical and statistical
modeling, measurement and research” (www.investopedia.com). Through
sales and expense diagnostics an analyst can tell if a company is
manipulating numbers and ratios to make the company look more
profitable or overestimate sales, for example. Since accounting disclosure
is flexible, companies can “smooth” out the numbers to make earnings look
a better or worse than they really are. Managers can make the numbers
look better when times are bad, and make the numbers look worse when
times are good. Managers take such action to buffer themselves from bad
times. Through the evaluation of certain sales and expense ratios, an
analyst can see how accurate or inaccurate the disclosed numbers really
are. We are going to evaluate sales manipulation diagnostics, which
include: net sales/cash from sales, net sales/inventory, and net
sales/accounts receivable. We are also going to evaluate some expense
manipulation diagnostics including asset turnover and cash flow from
operating activities (CFFO)/operating income.
Sales Manipulation Diagnostics
Sales manipulation diagnostics tell us how credible the revenues
being reported are. These ratios determine if there are any manipulations
or distortions that are present in the financial statements. We will look at
these ratios over a five-year period. When these ratios are singled out,
there is no real way to find any manipulations. However, with five-year
periods we can find trends that might be suspicious.
Net sales/Cash from Sales
The Net sales over cash from sales ratio shows analysts the actual amount
of cash that a firm is receiving from sales compared to the amount of
revenue recognized from sales during the period. This ratio should be very
close to one. This is because a firm wants to receive compensation when
they sell goods and services. If the ratio rises higher than one, this could
potentially be a red flag. This is because the firm would be recording too
many sales, when they aren’t actually receiving the cash. In this industry
the ratio is relatively close to one, which does not raise any questions to
whether disclosure is accurate or not. When looking at Clorox’s ratio, it is
easy to see that they are the most consistent and remain, on average, the
closest to one.
Net sales/Accounts Receivable
Net sales divided by accounts receivable helps us figure out if a firm’s
revenues from sales are matched by their accounts receivable. If there is a
steady increase in sales, it should be mirrored by a steady increase in
accounts receivable. This is because, when a company sells things on
credit, their accounts receivable should rise. If this doesn’t happen
however there is reason to believe that there is some manipulation. In the
figure below, you can see that the industry remains stagnant except for
Procter and Gamble. Despite the higher numbers, P&G is declining a little,
which can indicate that they either have trouble retrieving their accounts
receivable or their sales have decreased.
Net sales/Inventory
The ratio of net sales/inventory allows analysts to see if a firm's sales
are consistent with their inventory levels. When a firm increases their
sales, their inventory should decrease year by year. This action would
make the line graph increase. As we can see in the graph, trends seem to
be on the downward side of things. This can mean a variety of things,
such as firms might have too much inventory that’s not being used fast
enough, for example. The majorities of the firms listed in the figure below
are experiencing this and need to find ways to better utilize their
inventories.
Conclusion
Using sales manipulation diagnostics for the company’s in this
industry has shown that some company’s have a little more distortion than
others. Investors should show caution if they are examining a firm, and
they should show extreme caution if any distortions are found. Clorox’s
Net sales/Cash from sales is the most consistent in the industry. On
average, they are the closest to one for that ratio. Their Net
sales/Accounts receivable stays pretty consistent as well. Their average is
just above one, which means that they are in good shape when it comes to
their revenues and accounts receivables matching up. Clorox’s Net
sales/Inventory is right along with the industry norm. The firms, however,
need to find better ways to better utilize their inventories.
Expense Manipulation Diagnostics
Expense manipulation diagnostics will allow us to see if a firm is
manipulating their expenses to over or understate earnings. By comparing
Clorox to their three main competitors, we will be able to see if the
company is manipulating any of their expenses.
Asset Turnover
The asset turnover ratio is calculated by dividing the current year’s
sales by the previous year’s total assets. This ratio shows the amount of
sales produced for every dollar of assets produced. All of the firms in the
industry have held a steady turnover rate except Johnson and Johnson.
When you have a good asset turnover rate, this means you are efficient in
producing sales with the assets you have. A sharp decrease can raise a
“red flag,” in that the firm is understating their assets. However,
sometimes this can happen when a firm acquires another.
As you can see in the following chart, Clorox has a very steady asset
turnover rate. This means that the numbers that are expressed in their 10-
K’s are supported by their sales produced from every dollar of assets
produced. There are no potential “red flags” in the aspect of asset
turnover when it comes to Clorox. However, Johnson and Johnson may be
having some issues in this aspect. This can prove that, either they are not
efficient in producing sales with the assets they have, or they are
corrupting the numbers. This is an example of a “red flag.” When a firm
has a significant decrease in this ratio it can show signs of potential
corruption of numbers. It could be that the firm is understating their
assets in the form of income smoothing. Income smoothing happens when
a firm intentionally understates their assets so that they can look better in
times of need or low times in the industry. This is not a good thing to see
when an investor is looking to invest in this company. This should be an
issue that the investor needs some looking into to further understand what
is going on.
Cash Flows from Operations/Operating Income
CFFO/OI is a ratio that describes the amount of cash received from
operations and the actual operating income that is recorded on the
financial statements. A firm should preferably want this ratio to be (1:1);
this is because the cash that is affected by operating activities should be
recorded as nearly the same amount as operating income. Any sudden
decrease in the ratio would inform an analyst that the company is masking
expenses on the income statement.
Clorox has seen a very steady asset turnover ratio over the past five
years, which shows that the amount of cash flows from operations is
supported by the amount of operating income reported on the income
statement. The same can be said about the cleaning products industry
except for Procter and Gamble. From 2003-2005 there is a significant drop
in this ratio. This is because they had a drop in cash from their operating
activities while operating income was steadily increasing. This drop in cash
form their operating activity was due to initial operating expenses of the
Gillette acquisition. Their operating cash flows increased due to the benefit
of acquiring Gillette (PG 10-K). Over all this industry is in a pretty steady
state.
Cash Flows from Operations/Net Operating Assets
The ratio of cash flows from operations to net operating assets shows
how operating revenue is produced for every dollar in net operating assets
that the firm has. The higher this ratio gets the better. This means that
the firm is generating more revenue from its fixed assets.
In the chart below you can see that there is a steady industry
average around 0.8, but you can see that Johnson and Johnson is much
higher that the rest of the industry. This means that they are very efficient
in generating revenue for their fixed assets. They are using their Property,
Plant, and Equipment more efficient than the rest of the industry. When a
firm utilizes the technological advances in every way possible, it makes
things run much more efficient. Firms can use more efficient ways of using
electricity; they can outsource, or even purchase more efficient equipment
to keep their fixed costs down.
Pension Expense/SG&A
The pension expense to selling, general, and administrative expense
ratio shows how much of the firms money is being spent on retirees
relative to the other SG&A expenses. Firms want this ratio to be low
because that would mean they wouldn’t be spending as much on pensions
for the retired employees. The lower the portion of pension expense is to
SG&A, the better off the company will be.
As you can see from the following chart, the industry is somewhat
scattered. Clorox spends more, relative to the industry, on pension
expenses than does the rest of the industry. However, from 2005-2007
they have started to lower this ratio. This is happening as a result of their
SG&A increasing over those few years. This makes the portion of Pension
expense to the over all SG&A less. Over all, the industry holds relatively
low Pension expense to SG&A ratios, which is a very advantageous thing
for the firm.
The expense manipulation diagnostics show that Clorox has not
manipulated their expenses, and shows that their accounting polices are
straight forward and correct. The asset turnover and CFFO/NOA should be
looked at more carefully because Clorox doesn’t impair Goodwill. They
have maintained a steady ratio in the asset turnover ratio and CFFO/OI.
Also, Clorox’s pension expense to SG&A ratio is starting on a downward
trend, which is a very beneficial thing for the firm.
Conclusion
After running our Sales and Expense manipulation diagnostics, we
are able to state that there are no real areas of concern for Clorox’s
financials. Clorox has maintained consistent ratios throughout their
disclosure process, with the great deal of quality and quantity in their
disclosure. The computation of these ratios doesn’t raise any concerns.
Potential Red Flags
There are certain things that can look out of place when analyzing a
firm’s financial data; these things become “red flags.” When red flags have
been recognized, it requires further investigation by analysts to determine
the cause of these “red flags.” These signs show that management could
have possibly tampered or manipulated data to portray a better image of
the firm. With Clorox being a very reputable company, it seems
management has done a good job of disclosing their accounting policies;
however a few “red flags” were present.
After reviewing the financial statements of Clorox, we found that
goodwill is a major part of their total assets, accounting for around 23%.
Goodwill is an intangible asset that is impaired by upper management at
their discretion. This voluntary action creates a “red flag” because
management can manipulate the impairment to make the total assets
larger or smaller than they actually should be. Goodwill increased from
$744,000,000 in 2006 to $855,000,000 in 2007, and after further
investigation, we concluded that the reason it increased was due to the
acquisitions of new plants in Canada and Latin America. Because goodwill
accounts for 23% of Clorox’s total assets, their goodwill must be impaired.
Without the goodwill being impaired, the firm is overstating their assets,
which is cause for concern.
Through our review of the sales and expense manipulation
diagnostics, we found no “red flags.” The top competitors in the industry
all have similar significant financial ratios. Therefore, we have found little
reason to believe that upper management has manipulated the financial
statements of Clorox, aside from the non-impairment of goodwill. As
shown in the figures above, the financial ratios of Clorox seem to fall within
the industry norm.
In conclusion, with goodwill accounting for 23% of Clorox’s total
assets and they don’t impair it; we felt the need to restate it. Clorox also
has a high degree of disclosure and their sales and expense manipulation
diagnostics fall within the norms of the industry. For these reasons we
found only one potential “red flag,” the non-impairment of goodwill, to
cause concern.
Undo Accounting Distortions
An increase in goodwill may be a cause for concern that management
is distorting data. Given that 23% of Clorox’s total assets are goodwill, it
must be impaired. We impaired Clorox’s goodwill 20% for the past five
years. In the chart below, you can see that the goodwill has dropped a
good amount. This shows that Clorox has been overstating their goodwill
for the sake of looking a little better as a company.
Also, after the impairment of goodwill, their total assets have
changed. Since their goodwill was not being impaired, their total assets
were greater than what they really should have been. In the chart below,
you can see the significance the impairment has taken on the total assets
of the firm. As you can see, their goodwill is now less of the total assets
than is stated and this is reason for concern for investors.
Impairment of Goodwill 2003 2004 2005 2006 2007
Goodwill Before 730 742 743 744 855
Goodwill After 584 477 382 307 334
Clorox also has a high level of disclosure providing ample information
on how they calculate estimates such as discount rates. Because of the
level of transparency in the Company’s financial statements, there is little
reason to believe management has manipulated data to falsely represent
the market value of their firm, aside from the non-impairment of goodwill.
For these reasons, we restated the goodwill for Clorox. With the sales and
expense ratios falling within the industry norms, there is no reason to
believe management has manipulated that data.
Change of Percentage of Goodwill in Total Assets 2003 2004 2005 2006 2007
Assets Before Impairment 19.99% 19.35% 20.54% 20.58% 23.32%
Assets After Impairment 16.66% 12.79% 10.85% 8.66% 9.04%
Financial Analysis, Forecasting Financials and Cost
of Capital Estimation
In order to better asses the financial state of a firm, we use the
computation of financial ratios analysis and forecasting financials. First, we
examine the profitability and growth of a firm using the financial ratios.
Then, using the financial ratios previously stated, we forecast the financial
statements. Finally, forecasting is a valuable step in the valuation process
because it allows managers to better make future assumptions.
Financial Analysis
When evaluating a company, financial analysis is essential. Through
the use and careful examination of liquidity, profitability, and capital
structure ratios, we can better determine distortions in disclosure. If
benchmarked properly, this allows us to compare firms against their
competitors for several years. Benchmarking several years back allows
analysts to better spot trends and evaluate their industry.
Liquidity Analysis
Liquidity ratios determine how quickly a firm can convert their assets
into cash to cover their liabilities. The most common liquidity ratios include
the Current Ratio, Quick Asset Ratio, Accounts Receivable Turnover, Days
supply of Receivables, Inventory Turnover, Days supply of Inventory,
Working Capital Turnover, and the Cash to Cash Cycle. These ratios are
commonly used by banks to show credit risk. Managers of these firms feel
the pressures from the bankers to keep the ratios at certain sizes. These
certain quantities are what make the company eligible for loans.
Otherwise, these firms will have some trouble borrowing money from most
bankers.
Current Ratio
Current ratio is defined as a firm’s ability to pay short-term
obligations. This ratio is also known as the liquidity ratio; it basically tells
analysts how liquid the firm is. The higher this ratio gets, the more liquid a
firms is. This means that the firm is more capable of paying off its
obligations. When a company’s ratio is greater than one, it means they
have the ability to pay their debts if they came due at that point in time. If
a firm had a ratio of less than one, it would mean that the company would
not have enough money to cover its obligations at that point in time. This
proves that a company is in financial distress.
Current Ratio
0.00
0.50
1.00
1.50
2.00
2.50
3.00
2002 2003 2004 2005 2006 2007
CloroxProcter-GambleColgate-PalmoliveJohnson-JohnsonIndustry Average
2002 2003 2004 2005 2006 2007
Clorox 0.85 0.66 0.82 0.81 0.89 0.72
Procter-Gamble 0.96 1.23 0.77 0.81 1.22 0.78
Colgate-Palmolive 1.04 1.02 1.00 1.01 0.95 1.14
Johnson-Johnson 1.68 1.71 1.96 2.49 1.20 1.51
Industry Average 1.13 1.15 1.14 1.28 1.06 1.04
In the figure above you can see that the majority of the firms in this
industry are right around one, which is a good sign that the companies in
this industry are managing their current liabilities with current assets.
Johnson & Johnson, as you can see, has done very well with their current
ratio through the last six years. This firm has maintained a steady ratio of
above one, and even broke over two. In 2006 they dropped down to a
little above the industry average, which is not a huge problem, but the
started on their way back up. The industry average is fairly steady; right
around one, and Johnson & Johnson is the only company that is constantly
above the industry average. Clorox has an average below the industry
norm, which means that they need to have a more consistent ratio of
above one to be a favorable company.
Quick Asset Ratio
Quick asset ratio, also known as the “Acid Test,” is defined as an
indicator of a firm’s short-term liquidity. This ratio uses a firm’s most liquid
assets, such as cash and cash equivalents, securities, and A/R to meet its
short-term obligations. The higher this ratio becomes the better shape
that company is in, just the same as Current Ratio. This is a more
conservative measure of liquidity than current ratio, because it excludes
the inventory of a firm. Inventory is excluded because many firms have a
hard time converting their inventories into cash fast enough.
Quick Asset
0.000.200.400.600.801.001.201.401.601.802.00
2002 2003 2004 2005 2006 2007
CloroxProcter-GambleColgate-PalmoliveJohnson-JohnsonIndustry Average
2002 2003 2004 2005 2006 2007
Clorox 0.54 0.44 0.55 0.52 0.55 0.45
Procter-Gamble 0.53 0.75 0.45 0.49 0.68 0.40
Colgate-Palmolive 0.61 0.61 0.60 0.60 0.58 0.67
Johnson-Johnson 1.12 1.20 1.42 1.83 0.67 0.95
Industry Average 0.70 0.75 0.75 0.86 0.62 0.61
Looking at the graph, you can see that Johnson & Johnson has the
higher ratio again. The industry average is just below one and the majority
of the firms in this industry are below the industry average. Most of these
companies have consistency with their current ratios. Coming in second in
the industry is Colgate-Palmolive with and average of .61, which is not
quite one, but is still a favorable position. Clorox is right below Procter &
Gamble with an average of .51. With this quick asset ratio, Clorox needs
to either find a way to increase their quick assets or decrease their current
liabilities in order to become a more favorable company.
Accounts Receivable Turnover
Accounts receivable turnover is defined as a firm’s ability to extend
credit and collect their debts. This ratio examines the amount of time a
firm takes to recover its receivables. When a company has a low A/R T.O.,
the firm needs to rethink its credit policies to find a faster way of
recovering their A/R. When this is low, it means that it is taking a long
time for a firm to turn their receivables into cash, which can really hurt a
company when cash is needed.
A high A/R T.O. means that, either the company operates on a cash
basis and doesn’t use A/R T.O. much, or they are efficient in getting the
cash from their receivables. This is a very beneficial entity to a firm
because they will receive the cash that is owed to them in a much timelier
manner. This will create many advantages for the firm because they won’t
have to be waiting around for cash on products or services that they have
already provided.
Accounts Receivable Turnover
0
2
4
6
8
10
12
14
16
2002 2003 2004 2005 2006 2007
Clorox
Procter-Gamble
Colgate-PalmoliveJohnson-JohnsonIndustryAverage
2002 2003 2004 2005 2006 2007
Clorox 8.36 8.95 9.05 10.68 10.68 10.54
Procter-Gamble 13.02 14.28 12.66 13.56 11.92 11.54
Colgate-Palmolive 8.117 8.1039 8.02 8.71 8.04 8.2
Johnson-Johnson 6.72 6.37 6.93 7.21 6.12 6.47
Industry Average 9.05 9.43 9.17 10.04 9.19 9.19
In the figure above, the industry has an average around 9.3. This is
a good A/R T.O. rate for this industry. As you can see, Procter & Gamble
has the highest turnover rate in the industry. This means that they are
very efficient in getting cash from their receivables. They have good credit
policies in place that enforce the recovery of cash from products and
services that they have already performed. Clorox is right there along the
industry average, which is not necessarily a bad thing. This means that
they are taking good, not great, care of their receivables for their industry.
It is always in the firms favor to have the highest possible A/R T.O. to keep
cash on hand for the “money merry-go-round.”
Days Sales Outstanding
Day’s supply of receivables, also known as day’s sales outstanding,
measures a firm’s average number of days that it takes to collect revenue
after a sale has occurred. It is more favorable for a firm to have a low
DSO because this means it takes them fewer days to collect their accounts
receivable. As stated above, it is much more desirable for a company to do
this because they will have more cash to put back in the “money merry-go-
round.” This keeps a company from borrowing too much money because
they can’t get the A/R.
When a firm has a high DSO, it takes them longer to receive their
A/R. This means they are selling their products to their customers on
credit and taking too long to collect the cash. This can hurt a company
because they will have to borrow money to keep up with their production
speed.
Days Supply of Receivables
0
10
20
30
40
50
60
70
2002 2003 2004 2005 2006 2007
CloroxProcter-GambleColgate-PalmoliveJohnson-JohnsonIndustry Average
2002 2003 2004 2005 2006 2007
Clorox 43.66 40.78 40.33 34.18 34.18 34.63
Procter-Gamble 28.03 25.56 28.83 26.92 30.62 31.63
Colgate-Palmolive 44.97 45.04 45.5 41.9 45.4 44.51
Johnson-Johnson 54.32 57.3 52.67 50.62 59.64 56.41
Industry Average 42.75 42.17 41.83 38.41 42.46 41.80
In the figure above, you can see that Johnson & Johnson is having
trouble receiving their A/R. This can truly hurt this firm because they are
forced to borrow money to keep their production running and not receiving
cash fast enough to cover those expenses. Procter-Gamble has the lowest
DSR, which means that they are very efficient in getting that cash that is
owed to them in a timely manner. These numbers should coordinate with
A/R Turnover numbers; when one company has a high A/R T.O. they
should have a low DSR.
Inventory Turnover
Inventory turnover is defined as how many times a firm sells and
replaces their inventory in a given period. In this case, if you have a low
inventory turnover, the firm has low sales, which in turn creates excess
inventory. This is not good for a company because their inventory is
accumulating in their facilities and creating problems. The firm is not being
productive with their inventories, thus creating a low inventory turnover
rate.
When a firm has high inventory turnover, it is efficiently using its
inventory. This implies that the firm has either high sales or ineffective
buying (www.investopedia.com). Obviously, the better of the two is to
have high sales, which means the company is using up its inventories.
Inventory Turnover
0123456789
10
2002 2003 2004 2005 2006 2007
Clorox
Procter-Gamble
Colgate-PalmoliveJohnson-JohnsonIndustryAverage
2002 2003 2004 2005 2006 2007
Clorox 9.04 8.43 7.74 7.72 9.2 8.92
Procter-Gamble 6.07 6.08 5.7 5.55 5.27 5.38
Colgate-Palmolive 6.29 6.21 5.61 6.1 5.5 5.16
Johnson-Johnson 3.16 3.39 3.58 3.52 3.08 3.47
Industry Average 6.14 6.03 5.66 5.72 5.76 5.73
As shown in the chart, Clorox obviously has the best inventory
turnover. Clorox is the leader in its industry of productively using their
inventories. They order inventory that is just right for their production and
use just that amount. This insures that their inventory turnover is very
high. Johnson & Johnson is having some trouble with their inventory
turnover. They need to reevaluate their inventory ordering and usage. If
there is too much inventory ordered for the tasks at hand, the inventory
begins to accumulate. When this happens it makes it harder and harder to
turnover the inventory. Firms need to have policies that allow them to
order inventory for exactly what they need and only order more when
necessary. This prevents the inventory from accumulating.
Days Supply of Inventory
Day’s supply of inventory is a financial measure of how long it takes a
firm to turn its inventory into sales. The lower (shorter) this ratio is the
better for the firm. This means that inventory is being used up in a timely
manner. There is no excess inventory lying around, it is being efficiently
used and replaced quickly.
When a firm has a larger (longer) DSI, it means that the firm has
inventory sitting around for too long. The firm is not efficiently using the
inventory. This can hurt a firm in the “money merry-go-round” as well.
When inventory accumulates there is no cash inflow from selling those
inventories. This hinders this process, because there is no money to keep
the process moving. Therefore, the company has to borrow more money,
ultimately hurting the firm.
2002 2003 2004 2005 2006 2007
Clorox 40.38 43.3 47.16 47.28 39.67 40.92
Procter-Gamble 60.13 60.03 64.04 65.77 69.26 67.84
Colgate-Palmolive 58.03 58.78 65.06 59.84 66.36 70.74
Johnson-Johnson 115.51 107.67 101.95 103.69 118.51 105.19
Industry Average 68.51 67.45 69.55 69.15 73.45 71.17
In the figure above, you can see that Johnson & Johnson is having
some trouble with their DSI. This can be for many reasons. One being
that sales are slow for the company or two; they are ordering too much
inventory, which also makes inventory accumulate. As stated above, when
this number is high, it hinders the firm’s ability to get cash. When a firm
doesn’t have cash it slows a lot of things down, ultimately decreasing the
profitability of the firm.
Clorox is the leader in this industry. Clorox is very good at getting
the right amount of inventory needed and selling it when necessary. This
process, dramatically, decreases a firm's DSI. This is because that
inventory is being used and sold, creating some cash in-flow for the firm.
This, in turn, pushes the “money merry-go-round” that much faster. When
firms use their inventories efficiently, it is a great advantage to that firm.
It creates that much needed cash inflow to keep the firm running properly.
Working Capital Turnover
Working capital turnover is a comparison of generated sales to the
depletion of working capital. This whole process can tell an analyst how
efficiently a company is using its working capital to generate sales. Firms
use working capital (Current assets-Current Liabilities) to buy inventories
and fund operations. These inventories and operations are then turned
into revenues. The Working capital turnover ratio is used to analyze the
relationship of the money used to fund these operations and the revenues
from these operations. Basically this means that the higher the working
capital turnover the better. This is because the firm is generating a lot of
sales compared to the money it used to fund the sales.
2003 2004 2005 2006 2007
Clorox 3.28 2.70 ‐7.93 ‐29.77 28.35
Clorox Restated 3.73 3.28 ‐4.76 ‐7.75 ‐11.38
Colgate Palmolive 11.16 8.50 8.44 8.67 6.03
Proctor & Gamble 2.70 2.98 3.25 1.08 1.15
Johnson & Johnson 1.56 1.49 1.33 1.36 1.41
Industry Average 4.49 3.79 0.06 ‐5.28 5.11
In the industry, the majority of the firms are pretty close to the
industry average. This means that these firms are around a 1 to 1 basis
for sales and working capital. This is not the greatest thing for a firm to
have because they would like to have more sales from operations than
they spent on funding those operations. However, Clorox has a significant
change from 2005-2007. This significant change in Clorox’s WC T.O. is due
to their high investment in Working capital starting in 2005. Then the
working capital started to generate revenues in 2006 that, simultaneously,
increase the working capital turnover. When a firm has a positive Working
capital turnover, they are generating more money than they spent to fund
those same operations. Therefore, it is desirable to have as high a
Working Capital T.O. rate as possible.
Cash to Cash Cycle
The cash to cash cycle examines how long it takes for cash to go in
and out of the company. The process starts out with the company
investing in inventory, and then ends up with them collecting cash from
their receivables. This ratio is derived by adding the Days supply of
inventory to Days supply of receivables. The shorter (lower) this number is
the better for the firm. This is because it takes less time for the firm to get
cash back from putting money in for operations.
Clorox has the lowest average cash to cash cycle, which means that
they are very effective in putting money into operations and investments
and collecting their receivables quickly. This greatly helps a firm because
they don’t have to borrow as much money, making them deeper in debt.
This keeps a firm’s day-to-day operations running at an efficient pace.
2002 2003 2004 2005 2006 2007
Clorox 84.04 84.08 87.49 81.46 73.85 75.55
Procter‐Gamble 88.16 85.59 92.87 92.69 99.88 99.47
Colgate‐Palmolive 103 84.34 110.56 101.74 111.76 115.25
Johnson‐Johnson 169.83 164.97 154.62 154.31 178.15 161.6
Industry Average 111.26 104.75 111.39 107.55 115.91 112.97
Conclusion
In conclusion, firms use these ratios to determine how quickly they
can turn their assets to cash. When compared against the industry, Clorox
performed better than average. This firm is a very liquid firm and has the
ability to convert assets into cash in a very timely and efficient manner.
This overall makes the firm a more desirable and profitable company in the
long-run.
Profitability Analysis
Profitability analysis is performed to examine how efficient a firm is at
covering expenses with revenues. The higher these ratios, the more
profitable and efficient the firm usually is. The ratios include: gross profit
margin, operating profit margin, net profit margin, asset turnover, return
on assets, return on equity, the Altman Z-score, the internal growth rate,
and the sustainable growth rate.
Gross Profit Margin
Gross profit margin is a financial measurement used to assess a
firm's financial health by revealing the proportion of money left over from
revenues after subtracting for the cost of goods sold. Gross profit margin
serves as the source for paying additional expenses and future savings.
This ratio can be used to benchmark against competitors, and usually
firm’s in the industry with a higher profit margin seem to be more efficient.
Gross Profit Margin
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
2003 2004 2005 2006 2007
Clorox Proctor &GambleJohnson & JohnsonColgate-Palmolive
2003 2004 2005 2006 2007
Clorox 45.5% 44.0% 43.2% 42.2% 43.1%
Proctor &Gamble 49.0% 51.2% 51.0% 32.0% 52.0%
Johnson & Johnson 70.9% 71.7% 72.3% 71.8% 70.9%
Colgate-Palmolive 55.0% 55.1% 54.4% 54.8% 56.2%
Johnson and Johnson seem to have a considerably higher gross profit
margin than everyone else in the industry. Clorox, however, seems to be
performing less efficient than their main competitors. Clorox’s
management may need to investigate and look into their costs of goods
sold and try to keep them as low as possible to be able to perform more
efficiently in this industry.
Operating Profit Margin
The operating profit margin is a financial ratio used to measure a
company's pricing strategy and operating efficiency. Operating profit
margin is a measurement of what proportion of a firm’s revenue is left over
after paying for variable costs of production, such as advertising and
research and development costs. Operating profit margin gives us an idea
of what the company earns before interest and taxes on each dollar of
sales. When looking at the operating profit margin, it is best to look at the
changes over time and compare it to that of the company’s main
competitors in the industry. If the margin is increasing, the company is
earning more per dollar of sales. The higher the margin, the better it is for
the company.
Operating Profit Margin
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
2003 2004 2005 2006 2007
CloroxProctor &GambleJohnson & JohnsonColgate-Palmolive
2003 2004 2005 2006 2007
Clorox 20.1% 21.3% 17.9% 16.8% 17.6%
Proctor &Gamble 16.9% 18.3% 18.5% 19.4% 20.2%
Johnson & Johnson 21.7% 27.4% 25.8% 27.1% 23.8%
Colgate-Palmolive 21.9% 20.0% 19.5% 17.7% 19.2%
Again, Johnson and Johnson appear to lead in this ratio, which shows
that they are making more for every dollar of sale than that of their
competitors. Meanwhile Clorox has been experiencing decreasing profit
margins since 2004 and currently has the lowest operating profit margin
compared to their top competitors. Clorox appears to have more of a
problem than their competitors at achieving beneficial cost efficiency.
Net Profit Margin
Net profit margin is another financial ratio used to measure a
company’s profitability by taking net income and dividing by the company’s
total sales. Net profit margin measures how much a company actually
keeps in earnings for every dollar of sales. This is very useful in
benchmarking a company against their competitors. A higher net profit
margin indicates that a company is usually more profitable and better at
controlling costs than their competitors. Looking at the net income of a
company often doesn't tell the entire story. Increased earnings are good,
but an increase doesn’t mean that the profit margin of a company is
improving. For instance, a company may have an increase in net income,
but the costs of sales may be increasing at a higher rate, leading to less
efficiency.
Net Profit Margin
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
2003 2004 2005 2006 2007
CloroxProctor &GambleJohnson & JohnsonColgate-Palmolive
2003 2004 2005 2006 2007
Clorox 12.4% 13.2% 25.0% 9.6% 10.3%
Proctor &Gamble 11.0% 12.0% 12.2% 12.7% 13.5%
Johnson & Johnson 17.3% 20.7% 19.9% 18.0% 17.2%
Colgate-Palmolive 14.4% 12.5% 11.9% 11.1% 12.6%
According to the graph, Clorox’s net profit margin shot way up in
2005. This is due to a huge increase in net income. The reason that the
net income went out of the roof was because of Clorox’s relationship with a
company called Henkel. According to the 2005 10-K Clorox Company
published, Clorox developed a share exchange with Henkel to try to
increase profitability for the company. Henkel had some financial trouble
and Clorox made a deal to take over part of their production for a short
period of time. They included these earnings from this business venture as
“discontinued operations”, which increased their net income for the year
2005. Excluding that year, Clorox appears to have one of the lowest net
profit margins when compared to their competitors, which again shows
that they are struggling with cost efficiency more so than are their
competitors.
Asset Turnover
A company’s asset turnover is the amount of sales generated for
every dollar's worth of assets. It is calculated by dividing sales in dollars by
assets in dollars. Asset turnover measures a firm's efficiency at using its
assets in generating sales or revenue, and the higher the number the
better. There is also a pricing strategy correlated with asset turnover;
companies with low profit margins tend to have high asset turnover,
while those with high profit margins have low asset turnover.
Asset Turnover
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
1.60
2003 2004 2005 2006 2007
CloroxProctor &GambleJohnson & JohnsonColgate-Palmolive
2003 2004 2005 2006 2007
Clorox 1.13 1.14 1.14 1.28 1.34
Proctor &Gamble 1.06 1.18 0.99 1.11 0.56
Johnson & Johnson 1.03 0.98 0.87 0.92 0.87
Colgate-Palmolive 1.40 1.42 1.31 1.44 1.51
Clorox has on average a relatively higher asset turnover ratio than
their competitors. Clorox seems to be efficiently using their assets to make
revenues when compared to others in their industry. In the last few years,
Clorox has experienced an increase, which may be showing that they are
utilizing their assets more efficiently. As mentioned earlier, Clorox follows
the trend of low profit margins paired with a higher asset turnover ratio.
Return on Assets
Return on assets is measured by net income of the current year
divided by the total assets of the previous year. Return on assets is an
indicator of how profitable a company is relative to its total assets. ROA
gives an idea as to how efficient management is at utilizing its assets to
generate income. Return on assets shows how well the company turned
their invested capital, or assets, into earnings. The higher the number, the
better because the company is earning more net income with less money
invested in assets.
2003 2004 2005 2006 2007
Clorox 14.0% 15.0% 28.6% 12.3% 13.9%
Proctor &Gamble 11.7% 14.1% 12.1% 14.1% 7.6%
Johnson & Johnson 17.7% 17.6% 18.9% 19.0% 15.0%
Colgate-Palmolive 20.1% 17.7% 15.6% 15.9% 19.0%
Once again, the data from Clorox’s 2005 year spikes way up due to
the dramatic increase in net income. Relative to the others in their
industry, we can see that Clorox has experienced huge fluctuations in their
return on assets, jumping from around 15% in 2004, to over 26% in 2005,
then back down to around 12% in 2006. Excluding the data from the year
2005, Clorox is experiencing below par return on assets. This is suggesting
that management might be able to do a better job at converting their
invested money they have in assets into net income.
Return on Equity
Return on equity is a measure of a publicly traded company’s
profitability that reveals how much profit a company generates with the
money shareholders have invested, which is called equity. The ratio is
calculated by taking the net income of a given year divided by the previous
year’s shareholder’s equity. Return on equity is useful when comparing to
other competitors in similar industries.
2003 2004 2005 2006 2007
Clorox 0.36 0.45 0.71 -0.80 -3.21
Colgate Palmolive 4.06 1.50 1.08 1.00 1.23
Proctor & Gamble 0.38 0.40 0.42 0.50 0.16
Johnson & Johnson 0.85 0.78 0.33 0.29 0.27
As shown in the graph and table above, the household cleaner
industry has companies with extremely different values of return on equity.
It is difficult to draw conclusions by looking at the graph and table, but it is
very obvious that Clorox is doing absolutely horrible when it comes to
generating profits with their shareholder’s money. Clorox is doing so bad
that they have a negative return on equity. Management is doing a
horrible job at properly investing their shareholder’s money into the
company. Even though the industry is not doing a good job when it comes
to return on equity, Colgate-Palmolive seems to be the only company
efficiently generating shareholder’s money into earnings.
Internal Growth Rate
The Internal Growth Rate, or IGR, is a measure of the highest level
of growth achievable for a company without outside financial help. It is
calculated by using the company’s ROA and multiplying by 1 minus the
dividend payout ratio.
Internal Growth Rate
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
2003 2004 2005 2006 2007
Clorox ColgateJNJProctor
2003 2004 2005 2006 2007
Clorox 8.2% 8.3% 24.7% 7.5% 8.7%
Colgate 12.9% 9.1% 8.8% 7.4% 9.8%
JNJ 11.0% 10.3% 11.8% 11.7% 8.4%
Proctor 7.6% 8.3% 7.3% 8.1% 4.5%
As compared to their competitors, Clorox is achieving a similar rate to
their competitors, excluding 2005 when they had an unusually high amount
of net income. Clorox’s average, excluding 2005, is around 8.2%, which
means that the company was achieving an average growth rate of 8.2%
without any outside financial aid. The industry has experienced a slight
downward trend over the last couple of years, which shows that the
industry is becoming slightly more competitive.
Sustainable Growth Rate
The sustainable growth rate is a measure of how much a firm can
grow without having to borrow money from an outside source. After the
firm has passed this rate, it must borrow funds from another source to
facilitate growth.
Sustainable Growth Rate
-3.00
-2.00
-1.00
0.00
1.00
2.00
3.00
2003 2004 2005 2006 2007
Clorox ColgateJNJProctor
2003 2004 2005 2006 2007
Clorox 0.21 0.25 0.62 -1.93 -2.02
Colgate 2.61 0.77 0.61 0.47 0.63
JNJ 0.20 0.19 0.20 0.18 0.15
Proctor 0.23 0.22 0.24 0.27 0.10
Clorox has shown a dramatic drop in their SGR, even reaching
negative values, which shows that they can’t even grow without borrowing
money. This is mainly due to Clorox’s value of equity, which is currently
negative. Clorox has declined dramatically, while their competitors have
stayed on the positive side. Therefore, Clorox has performed poorly
compared to the others in their industry and should have management
reevaluate the way Clorox handles business.
Altman’s Z-score
The purpose of the Z-score is to access the company’s credit risk. A
score of under 1.81 means that the company is in danger of bankruptcy
according to the model, while a score of over 2.87 means that the
company is more financially secure.
Altman Z Score
00.5
11.5
22.5
33.5
4
2003 2004 2005 2006 2007
Clorox ColgateJNJProctor
2003 2004 2005 2006 2007
Clorox 2.93 3.21 3.19 3.45 2.06
Colgate 2.63 2.34 2.54 2.43 2.7
JNJ 2.75 3.14 3.24 2.25 2.24
Proctor 2.46 1.96 1.95 2.18 2.26
As shown by the graph and table, Clorox has maintained a
respectable Z-score of over 2.87 until 2007, where they dropped to a score
of 2.06. One reason for this may be a very significant drop in retained
earnings, which dropped from 3,939 in 2006 to only 185 in 2007. The
management at Clorox should really investigate the problem to avoid any
further drop in retained earnings, which would raise the Z-score back up to
over 2.87. Overall though, Clorox is a solid, credit worthy company.
Conclusion
By comparing a company’s profitability ratios to that of their
competitors’, an investor can grasp a good idea of how well the company is
doing. Overall, Clorox is being outperformed by their competitors. A
significant reason for this is due to the company’s smaller size than their
competitors. Clorox is showing weaknesses at being better at cost
efficiency than their competitors. Investors may be a little hesitant to jump
on Clorox until management finds a better-cost efficient system.
Capital Structure Ratios
When evaluating capital structure ratios, analysts are measuring how
a firm finances its overall operations and growth by using different sources
of funds. When referring to capital structure, most are referring to a firm’s
debt/equity ratio, which provides insight into how risky a company is.
Typically, firms more heavily financed by debt are highly levered and pose
greater risk. Therefore, analysts should pay close attention to the amount
of debt a firm carries on their balance sheet.
Debt/Equity Ratio
The debt/equity ratio is a primary indicator of how leveraged a firm
is. A high debt/equity ratio indicates that the firm has been aggressively
financing growth through debt. Shown in the graph below, Clorox restated
debt/equity is below the industry average indicating that they been
growing primarily due to equity financing with an increase in debt over the
last few years. These results are favorable when compared to the industry,
Debt/Equity
-30.00
-20.00
-10.00
0.00
10.00
20.00
30.00
2007 2006 2005 2004 2003
Clorox
Clorox Restated
Colgate-Palmolive
Proctor & Gamble
Johnson & Johnson
which is characterized by having higher debt/equity ratios.
Times Interest Earned
Times Interest Earned is used to measure a firm’s ability to meet its
obligations. “This ratio indicates how many times a company can cover its
interest charges on a pretax basis. Failing to do so could force a company
into bankruptcy.” (www.investopedia.com) For example, in 2007 Clorox has
a times interest earned ratio of 6.20, this means Clorox could pay their
interest expense 6.20 times with their income from operations. Therefore,
when computing this ratio, higher numbers indicate better performance.
Times Interest Earned
0.00
50.00
100.00
150.00
200.00
250.00
300.00
2007 2006 2005 2004 2003
Clorox
Clorox Restated
Colgate-Palmolive
Proctor & Gamble
Johnson & Johnson
Debt Service Margin
The debt service margin is a measurement that ties the ability to pay
off debt with cash flows from operations. When computing this ratio it is
important to remember to use the previous year’s cash flows from
operation, this way we can better account for the installment to be paid in
the current year. Also, higher debt service margins indicate better
performance. For example, in 2007 Clorox had a debt service margin of
4.54, this means that Clorox can retire their liabilities through operating
cash flows. As shown in the graph below, Clorox is consistent with the rest
of the industry.
Debt Service Margin
0.005.00
10.0015.0020.0025.0030.0035.0040.0045.00
2007 2006 2005 2004 2003
Clorox
Colgate-Palmolive
Proctor & Gamble
Johnson & Johnson
Cost of Capital Estimation
Cost of Equity
The cost of equity is the rate of return that investors earn for investing in a
company’s stock. The riskier the stock is the more return an investor will
require to invest in it, so riskier stocks have higher costs of equity. To
determine the cost of equity the capital asset pricing model, or CAPM, was
used. The CAPM consists of the risk free rate, beta, and the market risk
premium. The risk free rate is the 10 year U.S. Treasury yield. The U.S.
Treasury securities are considered risk free because they are backed by the
full faith of the U.S. government, which almost never defaults and has
always paid their investors. The beta is an estimate of the systematic risk,
or market risk. The market risk premium is the difference between the
long term market rate and the risk free rate.
The first thing we had to do to find the cost of equity for Clorox was
estimate its beta coefficient. To estimate the beta coefficient we used
regression analysis. We did this over five different points on the yield
curve: 3 months, 6 months, 2 years, 5 years, and 10 years. For each of
the five different points we performed regressions using 72 months, 60
months, 48 months, 36 months, and 24 months of returns to determine
which beta coefficient showed the most explanatory power over Clorox’s
returns. For the regressions we first had to find the returns for Clorox’s
stock over the past 72 months. After this we found the market return over
the last 72 months using the S&P 500. Once we had the market return we
used the treasury rates for 3 months, 6 months, 2 years, 5 years, and 10
years to find the market risk premiums. With these values we were able to
perform regressions with the firms return and the market risk premium to
determine a suitable beta coefficient.
To determine the right beta coefficient to use we analyzed the
adjusted R2 of the regression results. A higher adj. R2 means a higher
percentage of the dependent variable, Clorox’s returns, is explained by the
independent variable, the beta coefficient. The regression that had the
highest adj. R2, 13.6 %, was the 24 month regression using the 5 year
treasury yield. The beta coefficient for this regression was 0.579, which is
very close to the published beta on yahoo.com of 0.55. Although the
explanatory power for this beta coefficient was only 13.6%, we felt it was
an appropriate estimate of beta to use for our cost of equity. We decided
this because of the nature of the products Clorox sells, which are cleaning
supplies. It the economy makes a downturn and customers spend less
they will still need to buy Clorox’s products, which means its beta would be
less than one.
To find the cost of equity we used the Capital Asset Pricing Model, or
CAPM. The equation for the CAPM is: Ke=Rf + B(MRP)
Where,
Ke= the cost of equity
Rf= the risk free rate
B= the beta coefficient
MRP= the market risk premium
The risk free rate we used was the 10 year treasury note of 3.88%.
The market risk premium used was the historic market risk premium of
7%. The beta used was 0.579, which was found in our regression analysis.
The cost of equity was determined to be 7.93%, and with a 0.7%
adjustment for size it was 7.23%. Below are the results of our regression
analysis.
3 Month Months Adj R^2 Beta Cost of Equity Size Adj. Cost of Equity
72 13.14% 0.53 7.57% 6.87% 60 3.44% 0.35 6.35% 5.65% 48 7.66% 0.50 7.36% 6.66% 36 10.88% 0.56 7.77% 7.07% 24 13.38% 0.58 7.91% 7.21%
6 Month Months Adj R^2 Beta Cost of Equity Size Adj. Cost of Equity
72 13.15% 0.53 7.57% 6.87% 60 3.44% 0.35 6.35% 5.65% 48 7.65% 0.50 7.36% 6.66% 36 10.90% 0.56 7.78% 7.08% 24 13.41% 0.58 7.92% 7.22%
2 Year Months Adj R^2 Beta Cost of Equity Size Adj. Cost of Equity
72 13.14% 0.53 7.57% 6.87% 60 3.37% 0.35 6.34% 5.64% 48 7.63% 0.50 7.36% 6.66% 36 10.97% 0.56 7.79% 7.09% 24 13.51% 0.58 7.93% 7.23%
5 Year Months Adj R^2 Beta Cost of Equity Size Adj. Cost of Equity
72 13.10% 0.53 7.56% 6.86% 60 3.30% 0.35 6.33% 5.63% 48 7.62% 0.50 7.35% 6.65% 36 11.08% 0.56 7.80% 7.10% 24 13.60% 0.58 7.93% 7.23%
10 Year Months Adj R^2 Beta Cost of Equity Size Adj. Cost of Equity
72 13.14% 0.53 7.57% 6.87% 60 3.48% 0.35 6.36% 5.66% 48 7.82% 0.50 7.36% 6.66% 36 11.19% 0.56 7.78% 7.08% 24 13.59% 0.57 7.88% 7.18%
Upper Bound Cost of Equity 11.14%Lower Bound Cost of Equity 3.32%
Alternate Estimate of Cost of Capital
Another way to find the cost of capital is to use the equation,
Ke =
(ROE + (P/B -
1)*g
P/B
Where,
Ke = cost of equity
ROE = return on equity
P/B = price to book ratio
g = growth rate of earnings
This is equation does not work for Clorox because they have a
negative book value of stock and a negative return on equity. If we did
use this equation it would show Clorox having a cost of equity of 14.91%.
We didn’t think that this was an accurate estimate of cost of equity
because of the negative price to book ratio and a negative return on
equity.
Cost of Debt
The cost of debt is amount of interest a company pays on its debt
instruments. Because debt is less risky than equity it will be lower than the
cost of equity. To find the cost of debt we took the weights of all of
Clorox’s liabilities as compared to total liabilities. After this we found the
appropriate interest rate that was associated to the liability. We multiplied
the weights of the liabilities with the appropriate interest rates to find a
weighted average cost of debt.
To get the weighted average cost of debt we had to find the correct
interest rates for the different liabilities. The interest rates for notes and
loans payable, current maturity of long term debt, long term debt, and
other liabilities were all disclosed in Clorox’s 10-k. For account payable and
accrued liabilities we used the 3 month AA nonfinancial commercial paper
rate on 5/30/2008. For income tax payable and deferred income tax the
10 year treasury rate on 5/30/2008 was used. These rates were found on
the St. Louis Federal Reserve Bank’s website,
http://research.stlouisfed.org. We found Clorox’s weighted average cost of
debt to be 4.39%.
Cost of Debt Debt Interest Rate Weight WACDCurrent liabilities Notes and loans payable $
74 5.72 2.12% 0.12Current maturities of long-term debt 500 5.49 14.31% 0.79Accounts payable 329 2.03 9.41% 0.19Accrued liabilities 507 2.03 14.51% 0.29Income taxes payable 17 4.06 0.49% 0.02Total current liabilities 1,427 Long-term debt 1,462 5.11 41.83% 2.14Other liabilities 516 5 14.76% 0.74Deferred income taxes 90 4.06 2.58% 0.10Total liabilities 3,495 100.00% 4.39
Weighted Average Cost of Capital
The weighted average cost of capital is the total cost of both equity
and debt. To find the weighted average cost of capital, or WACC, the cost
of debt is multiplied by the proportion of debt to the sum of debt and
equity, and the cost of equity is multiplied by the proportion of equity to
the sum of debt and equity. These values are added to together to
determine the WACC. By using our cost of equity and cost of debt we
found the before tax WACC for Clorox to be 6.46%, and the after tax
WACC to be 4.62%.
Weighted Average Cost of Capital Cost of Debt D/D+E Tax Rate Cost of Equity E/D+E WACCWACCBT 4.39% 0.27 0 7.23% 0.73 6.46%WACCAT 4.39% 0.27 35% 7.23% 0.73 4.62%
Financial Statements Forecasting
Forecasting financial statements is very important to business
valuation. By using business and industry analysis, along with ratio
analysis, analysts are able to forecast a company’s financial statements for
a better valuation. The first step in forecasting is to transform the financial
statements into common size statements that make them easier to
compare. Next we used sales growth rates, trends in ratios, and averages
to make our forecasts. After utilizing these methods we were able to
forecast Clorox’s income statement, balance sheet, and statement of cash
flows for ten years in the future. We also forecasted the restated income
statement and restated balance sheet for ten years.
Income Statement
The income statement is the easiest and most reliable financial
statement to forecast. That is why it is usually the starting point in
financial statement forecasts. We started by analyzing Clorox’s past five
years of income statements and turning them into a common size income
statement, which puts every line item as a percent of net sales. By doing
this it is easier to compare the different items on the income statement.
When we studied this data we felt we could accurately forecast net sales,
cost of goods sold, gross profit, selling and administrative expenses,
advertising costs, research and development costs, and net earnings.
To forecast net sales we looked at the trend of growth for the past
five years, which were between 4.2% and 5.8%. We decided that a 5.6%
growth rate for 2008 and a 5.2% growth rate for the next nine years would
be appropriate. The reason for this was that the sales growth rate had
been steadily growing from 2003 to 2006, but took a small drop in 2007.
By using 5.6% for 2008 and 5.2% for the following years we felt we could
account for any small decreases in the actual future sales growth rates.
The next line item we forecasted was the cost of products sold.
During the last five years the cost of products sold has been pretty
consistent staying within about three percentage points, so we took the
average of the percent of cost of products sold to net sales over the last
five years, which was 56.4%, to forecast the next ten years. To forecast
the gross profit we subtracted cost of products sold from the net sales of
each of the future ten years. After this we forecasted the selling and
administrative expenses. The SA%E was very consistent from 2003 to
2007, varying only by about one percent, so we felt it was appropriate to
take the average of these years and use the average to forecast the next
ten years. The average selling and administrative expenses was 13.2%.
The advertising costs had also been very stable and around ten percent for
the past five years, so we used it to forecast the advertising costs. Another
item that stayed consistent over the past five years was research and
development costs, which stayed around two percent. We decided the
average of these years, which was a 2.05% increase, was the appropriate
forecasting measure. Advertising and research and development are both
key success factors for Clorox so it was important to forecast these
expenses to get an accurate view of Clorox for the next ten years.
The last item on the income statement we forecasted was the net
earnings. In all the previous five years, except 2005, the net earnings
were pretty stable ranging from 9.56% to 13.19% of net sales. In 2005,
the net earnings to net sales jumped up to 24.98%. We decided that this
was an outlier and would not help to produce an accurate forecast, so we
used 11.25%, which is more consistent with the rest of the years, to
forecast the future net earnings.
Clorox's Income Statement Actual Income Statement Forecasted Income Statement (in millions) 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Sales Growth 4.2% 4.4% 5.4% 5.8% 4.4% 5.6% 5.2% 5.2% 5.2% 5.2% 5.2% 5.2% 5.2% 5.2% 5.2% Net sales
3,986 4,162
4,388
4,644
4,847
5,118
5,385
5,665
5,959
6,269
6,595
6,938
7,299
7,678
8,078
Cost of products sold 2,171
2,331
2,493
2,685
2,756
2,887
3,037
3,195
3,361
3,536
3,720
3,913
4,116
4,331
4,556
Gross profit 1,815
1,831
1,895
1,959
2,091
2,231
2,348
2,470
2,598
2,733
2,875
3,025
3,183
3,347
3,522
Selling and administrative expenses 523
543
551
631
642
676
711
748
787
828
871
916
963
1,014
1,066
Advertising costs 446
420
435
450
474
512
538
566
596
627
660
694
730
768
808
Research and development costs 75
84
88
99
108
105
110
116
122
129
135
142
150
157
166
Restructuring and asset impairment costs 33
11
36
1
13
Interest expense 28
30
79
127
113
Other (income) expense: Equity earnings and gain on exchange of Henkel Iberica, S.A.
(2) (11)
(25)
-
-
Other, net (6)
2
2
(2)
(2)
Earnings from continuing operations before income taxes 718
752
729
653
743
Income taxes on continuing operations 257
262
214
210
247
Reversal of deferred taxes from equity investment in Henkel Iberica, S.A.
-
-
(2)
-
- Earnings from continuing operations
461 490
517
443
496
Discontinued operations: Gain on exchange
-
- 550
-
-
Earnings from exchanged businesses 84
87
37
1
-
Reversal of deferred taxes from exchanged businesses -
-
6
-
-
Losses from Brazil operations (26)
(4)
-
Income tax benefit (expense) on discontinued operations (26)
(24)
(14)
-
5
Earnings from discontinued operations 32
59
579
1
5
Net earnings 493
549
1,096
444
501
576
606
637
670
705
742
781
821
864
909
Common Size Income Statement Actual Income Statement Forecasted Income Statement (in millions) 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Sales Growth 4.2% 4.4% 5.4% 5.8% 4.4% 5.6% 5.2% 5.2% 5.2% 5.2% 5.2% 5.2% 5.2% 5.2% 5.2%
Net sales 100.00% 100.00% 100.00% 100.00% 100.00%100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Cost of products sold 54.47% 56.01% 56.81% 57.82% 56.86%56.40% 56.40% 56.40% 56.40% 56.40% 56.40% 56.40% 56.40% 56.40% 56.40%
Gross profit 45.53% 43.99% 43.19% 42.18% 43.14%43.59% 43.60% 43.60% 43.60% 43.60% 43.60% 43.60% 43.61% 43.59% 43.60%
Selling and administrative expenses 13.12% 13.05% 12.56% 13.59% 13.25%13.20% 13.20% 13.20% 13.20% 13.20% 13.20% 13.20% 13.20% 13.20% 13.20%
Advertising costs 11.19% 10.09% 9.91% 9.69% 9.78%10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00%
Research and development costs 1.88% 2.02% 2.01% 2.13% 2.23%2.05% 2.05% 2.05% 2.05% 2.05% 2.05% 2.05% 2.05% 2.05% 2.05%
Restructuring and asset impairment costs 0.83% 0.26% 0.82% 0.02% 0.27%
Interest expense 0.70% 0.72% 1.80% 2.73% 2.33%
Other (income) expense:
Equity earnings and gain on exchange of Henkel Iberica,
S.A. -0.05% -0.26% -0.57%
Other, net -0.15% 0.05% 0.05% -0.04% -0.04%
Earnings from continuing operations before income taxes
18.01% 18.07% 16.61% 14.06% 15.33%
Income taxes on continuing operations 6.45% 6.30% 4.88% 4.52% 5.10%
Reversal of deferred taxes from equity investment in
Henkel Iberica, S.A. -0.05%
Earnings from continuing operations 11.57% 11.77% 11.78% 9.54% 10.23%
Discontinued operations:
Gain on exchange 12.53%
Earnings from exchanged businesses 2.11% 2.09% 0.84% 0.02%
Reversal of deferred taxes from exchanged businesses
0.14%
Losses from Brazil operations -0.65% -0.10%
Income tax benefit (expense) on discontinued operations
-0.65% -0.58% -0.32% 0.10%
Earnings from discontinued operations 0.80% 1.42% 13.20% 0.02% 0.10%
Net earnings 12.37% 13.19% 24.98% 9.56% 10.34%11.25% 11.25% 11.25% 11.25% 11.25% 11.25% 11.25% 11.25% 11.25% 11.25%
Restated Income Statement
The change in goodwill is reflected in the following restated income
statements. By impairing goodwill by 20% over the past fiver years, we
felt we had a more accurate picture of Clorox’s financial position. This
impairment made some key changes to the income statement. First we
had to add goodwill impairment costs of $146, $115, $94, $75, and $42
million to the previous five years of Clorox’s income statement. This
reduced net earnings for those years, so we had to re-evaluate our
forecast of net earnings for the next ten years. We lowered the estimated
net earnings to net sales percentage to 10.2%. This gave us a more
accurate view of Clorox’s net earnings in the future.
Restated Income Statement Restated Income Statement Forecasted Restated Income Statement (in millions) 2003 2004 2005 2006 2007
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Sales Growth 4.2% 4.4% 5.4% 5.8% 4.4% 5.6% 5.2% 5.2% 5.2% 5.2% 5.2% 5.2% 5.2% 5.2% 5.2%
Net sales 3,986
4,162
4,388
4,644
4,847
5,118
5,385
5,665
5,959
6,269
6,595
6,938
7,299
7,678
8,078
Cost of products sold 2,171
2,331
2,493
2,685
2,756
2,887
3,037
3,195
3,361
3,536
3,720
3,913
4,116
4,331
4,556
Gross profit 1,815
1,831
1,895
1,959
2,091
2,232
2,348
2,470
2,598
2,733
2,875
3,025
3,182
3,348
3,522
Selling and administrative expenses 523
543
551
631
642
691
727
765
804
846
890
937
985
1,037
1,090
Advertising costs 446
420
435
450
474
512
538
566
596
627
660
694
730
768
808
Research and development costs 75
84
88
99
108
105
110
116
122
129
135
142
150
157
166
Restructuring and asset impairment costs 33
11
36
1
13
Goodwill impairment costs 146
115
94
75
42
48
39
32
26
21
17
14
11
9
7
Interest expense 28
30
79
127
113
Other (income) expense:
Equity earnings and gain on exchange of Henkel Iberica,
S.A. (2)
(11)
(25)
-
-
Other, net (6)
2
2
(2)
(2)
Earnings from continuing operations before income taxes 572
637
635
578
701
Income taxes on continuing operations 200
223
222
202
245
Reversal of deferred taxes from equity investment in
Henkel Iberica, S.A. -
-
(2)
-
-
Earnings from continuing operations 372
414
415
376
456
Discontinued operations:
Gain on exchange -
-
550
-
-
Earnings from exchanged businesses 84
87
37
1
-
Reversal of deferred taxes from exchanged businesses -
-
6
-
-
Losses from Brazil operations (26)
(4)
-
Income tax benefit (expense) on discontinued operations (26)
(24)
(14)
-
5
Earnings from discontinued operations 32
59
579
1
5
Net earnings 404
473
994
377
461
522
549
578
608
639
673
708
744
783
824
Restated Common Size Income Statement Restated Income Statement Forecast Restated Income Statement (in millions) 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Sales Growth 4.2% 4.4% 5.4% 5.8% 4.4% 5.6% 5.2% 5.2% 5.2% 5.2% 5.2% 5.2% 5.2% 5.2% 5.2% Net sales 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Cost of products sold 54.47% 56.01% 56.81% 57.82% 56.86% 56.40% 56.40% 56.40% 56.40% 56.40% 56.40% 56.40% 56.40% 56.40% 56.40% Gross profit 45.53% 43.99% 43.19% 42.18% 43.14% 43.60% 43.60% 43.60% 43.60% 43.60% 43.60% 43.60% 43.60% 43.60% 43.60% Selling and administrative expenses
13.12% 13.05% 12.56% 13.59% 13.25%
13.50% 13.50% 13.50% 13.50% 13.50% 13.50% 13.50% 13.50% 13.50% 13.50% Advertising costs 11.19% 10.09% 9.91% 9.69% 9.78% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% Research and development costs
1.88% 2.02% 2.01% 2.13% 2.23% 2.05% 2.05% 2.05% 2.05% 2.05% 2.05% 2.05% 2.05% 2.05% 2.05%
Restructuring and asset impairment costs
0.83% 0.26% 0.82% 0.02% 0.27%
Goodwill impairment costs
3.66% 2.76% 2.14% 1.61% 0.87%
Interest expense 0.70% 0.72% 1.80% 2.73% 2.33% Other (income) expense:
Equity earnings and gain on exchange of Henkel Iberica,
S.A. -0.05% -0.26% -0.57% Other, net -0.15% 0.05% 0.05% -0.04% -0.04% Earnings from continuing operations before income taxes
14.35% 15.31% 14.47% 12.45% 14.46%
Income taxes on continuing operations
5.02% 5.36% 5.06% 4.36% 5.06%
Reversal of deferred taxes from equity investment in
Henkel Iberica, S.A. -0.05% Earnings from continuing operations
9.33% 9.95% 9.45% 8.09% 9.40%
Discontinued operations:
Gain on exchange 12.53% Earnings from exchanged businesses
2.11% 2.09% 0.84% 0.02%
Reversal of deferred taxes from exchanged businesses
0.14%
Losses from Brazil operations
-0.65% -0.10%
Income tax benefit -0.65% -0.58% -0.32% 0.10%
(expense) on discontinued operations Earnings from discontinued operations
0.80% 1.42% 13.20% 0.02% 0.10%
Net earnings 10.13% 11.37% 22.65% 8.11% 9.50% 10.20% 10.20% 10.20% 10.20% 10.20% 10.20% 10.20% 10.20% 10.20% 10.20%
Balance Sheet
After forecasting the income statement we could forecast the Clorox’s
balance sheet. The balance sheet is more difficult to forecast than the
income statement and there is no set rules on how to form a common size
balance sheet. In order to do this we showed all assets as a percentage of
total assets, and all liabilities and stockholders’ equity as a percentage of
total liabilities and stockholders’ equity. We forecasted the total current
assets, the property, plant and equipment, goodwill, total non-current
assets, and total assets on the right side of the balance sheet. On the left
side we forecasted total current liabilities, total liabilities, retained earnings,
stockholders’ equity, and total liabilities and stockholders’ equity.
We started with the total current assets. To forecast the total
current assets we found the growth rates from the past five years and used
the average of these growth rates to forecast the this line item ten years.
We also used an average growth rate for the property, plant, and
equipment, which had been consistent for the past five years. Goodwill
was also very stable at around 20% of total assets, so its average growth
rate was used to forecast it into the future. The total non-current assets
were also forecasted using an average of the past five-year’s growth rates.
We chose to use the average growth rates for the past four line items
because they showed such consistency on the common size balance sheet.
To forecast the total assets, the asset turnover ratio was used. The asset
turnover ratio divides this year’s sales by last year’s assets, which shows a
more accurate picture of where the sales are coming from. An asset
turnover ration of 1.35 was used, which was the average of the past five
years asset turnover ratios.
Next we forecasted the total current liabilities. To forecast the total
current liabilities we used the average of the past five-year’s current ratios,
which was 0.79. The current ratio is the current assets divided by the
current liabilities, so by dividing our forecasted current assets by 0.79, we
were able to determine the total current liabilities. After this we forecasted
the retained earnings. To forecast the retained earnings we took the
previous year’s retained earnings and added the current year’s net
earnings and then subtracted the current year’s dividend payouts. This
gave us the current years retained earnings. After we had forecasted the
retained earnings we could forecast the total stockholder’s equity. To do
this we took the previous year’s stockholder’s equity and added the
difference in the current years retained earnings and the previous years
retained earnings. This gave us the change in stockholder’s equity. Once
the total stockholder’s equity was known we subtracted it from the total
assets to obtain the total liabilities. Finally, we were able to forecast the
total liabilities and stockholders’ equity by adding the total liabilities and
total stockholders’ equity of our forecast years.
Clorox Balance Sheet Actual Balance Sheet Forecasted Balance Sheet
(in millions) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
ASSETS
Current assets
Cash and cash equivalents 177
172
232
293
192
182
Receivables, net 481
463
460
411
435
460
Inventories, net 252
264
301
323
292
309
Other current assets 83
46
50
63
88
81
51
6
Total current assets 1,044 951 1,043 1,090 1,007
1,032
1,084
1,116
1,150
1,184
1,220
1,256
1,294
1,333
1,373
1,414
Property, plant and equipment, net 992 1,072 1,052
999 1,004
976
968
961
953
946
939
931
924
917
910
902
Goodwill 728
730
742
743
744
855
863
870
878
885
893
901
909
917
925
933
Trademarks and other intangible assets, net 573
651
633
599
604
613
Other assets 187
248
364
186
257
190
Total Non-Current assets 2,480 2,701 2,791 2,527 2,609 2,634
2,687
2,740
2,795
2,851
2,908
2,966
3,026
3,086
3,148
3,211
Total assets 3,524 3,652 3,834 3,617 3,616 3,666
3,989
4,196
4,414
4,644
4,885
5,139
5,406
5,688
5,983
6,294
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities
Notes and loans payable 330
361
289
359
156
74
Current maturities of long-term debt 2
213
2
2
152
500
Accounts payable 330
312
310
347
329
329
Accrued liabilities 510
537
643
614
474
507
Income taxes payable 54
28
24
26
19
17
Total current liabilities 1,226 1,451 1,268 1,348 1,130 1,427
856
882
908
935
963
992
1,022
1,053
1,084
1,117
Long-term debt 678
495
475 2,122 1,966
1,462
Other liabilities 231
376
377
618
547
516
Deferred income taxes 23
115
174
82
129
90
Total liabilities 2,158 2,437 2,294 4,170 3,772 3,495
3,435
3,240
3,036
2,822
2,597
2,362
2,115
1,855
1,584
1,299
Stockholders' equity (deficit)
Common Stock 250
250
250
250
250
159
Additional paid-in capital 222
255
301
328
397
481
Retained earnings 2,270 2,565 2,846 3,684 3,939 185
568
970
1,392
1,836
2,302
2,792
3,306
3,846
4,414
5,010
RE check 568
970
1,392
1,836
2,302
2,792
3,306
3,846
4,414
5,010
Treasury shares, at cost (1,070) (1,507) (1,570) (4,463) (4,527) (445)
Accumulated other comprehensive net losses (296)
(339)
(274)
(336)
(215)
(209)
Unearned compensation (10)
(9)
(13)
(16)
Stockholders' equity (deficit) 1,366 1,215 1,540 (553)
(156)
171
554
956
1,378
1,822
2,288
2,778
3,292
3,832
4,400
4,996
Total liabilities and stockholders' equity (deficit) 3,524 3,652 3,834 3,617 3,616 3,666
3,989
4,196
4,414
4,644
4,885
5,139
5,406
5,688
5,983
6,294
Clorox Common Size Balance Sheet Actual Balance Sheet Forecasted Balance Sheet
(in millions) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
ASSETS
Current assets
Cash and cash equivalents 5.02% 4.71% 6.05% 8.10% 5.31% 4.96%
Receivables, net 13.65% 12.68% 12.00% 11.36% 12.03% 12.55%
Inventories, net 7.15% 7.23% 7.85% 8.93% 8.08% 8.43%
Other current assets 2.36% 1.26% 1.30% 1.74% 2.43% 2.21%
1.45% 0.16%
Total current assets 29.63% 26.04% 27.20% 30.14% 27.85% 28.15% 27.17% 26.60% 26.04% 25.50% 24.97% 24.44% 23.93% 23.43% 22.94% 22.46%
Property, plant and equipment, net 28.15% 29.35% 27.44% 27.62% 27.77% 26.62% 24.28% 22.90% 21.60% 20.37% 19.21% 18.12% 17.09% 16.12% 15.20% 14.34%
Goodwill 20.66% 19.99% 19.35% 20.54% 20.58% 23.32% 21.62% 20.74% 19.89% 19.07% 18.29% 17.53% 16.81% 16.12% 15.46% 14.83%
Trademarks and other intangible assets, net 16.26% 17.83% 16.51% 16.56% 16.70% 16.72%
Other assets 5.31% 6.79% 9.49% 5.14% 7.11% 5.18%
Total Non-Current assets 70.37% 73.96% 72.80% 69.86% 72.15% 71.85% 67.36% 65.31% 63.32% 61.40% 59.53% 57.72% 55.96% 54.26% 52.61% 51.01%
Total assets 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities
Notes and loans payable 9.36% 9.88% 7.54% 9.93% 4.31% 2.02%
Current maturities of long-term debt 0.06% 5.83% 0.05% 0.06% 4.20% 13.64%
Accounts payable 9.36% 8.54% 8.09% 9.59% 9.10% 8.97%
Accrued liabilities 14.47% 14.70% 16.77% 16.98% 13.11% 13.83%
Income taxes payable 1.53% 0.77% 0.63% 0.72% 0.53% 0.46%
Total current liabilities 34.79% 39.73% 33.07% 37.27% 31.25% 38.93% 21.46% 21.01% 20.57% 20.14% 19.72% 19.31% 18.91% 18.51% 18.12% 17.74%
Long-term debt 19.24% 13.55% 12.39% 58.67% 54.37% 39.88%
Other liabilities 6.56% 10.30% 9.83% 17.09% 15.13% 14.08%
Deferred income taxes 0.65% 3.15% 4.54% 2.27% 3.57% 2.45%
Total liabilities 61.24% 66.73% 59.83% 115.29% 104.31% 95.34% 86.12% 77.22% 68.78% 60.77% 53.16% 45.95% 39.11% 32.62% 26.47% 20.63%
Stockholders' equity (deficit)
Common Stock 7.09% 6.85% 6.52% 6.91% 6.91% 4.34%
Additional paid-in capital 6.30% 6.98% 7.85% 9.07% 10.98% 13.12%
Retained earnings 64.42% 70.24% 74.23% 101.85% 108.93% 5.05% 14.23% 23.11% 31.54% 39.54% 47.12% 54.32% 61.15% 67.62% 73.77% 79.59%
RE check 14.24% 23.11% 31.54% 39.54% 47.12% 54.32% 61.15% 67.62% 73.77% 79.59%
Treasury shares, at cost -30.36% -41.27% -40.95% -
123.39% -
125.19% -12.14%
Accumulated other comprehensive net losses -8.40% -9.28% -7.15% -9.29% -5.95% -5.70%
Unearned compensation -0.28% -0.25% -0.34% -0.44%
Stockholders' equity (deficit) 38.76% 33.27% 40.17% -15.29% -4.31% 4.66% 13.88% 22.78% 31.22% 39.23% 46.84% 54.05% 60.89% 67.38% 73.53% 79.37%
Total liabilities and stockholders' equity (deficit) 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Restated Balance Sheet
The impairment to goodwill also made some changes to the balance
sheet. First the goodwill asset had to be lowered to accommodate for the
20% impairment. Before the restatement of goodwill, it made up about
twenty percent of Clorox’s total assets every year for the past five years.
After the restatement the percent of total assets was lowered to below ten
percent in 2007. This also lowered the retained earnings for Clorox by the
amount of goodwill from their original balance sheet minus the amount of
goodwill on the restated balance sheet. We found the forecast for retained
earnings the same way we did in the actual balance sheet, only with
smaller retained earnings. This dramatically decreased stockholders’ equity
to negative $9,865 million in 2017.
Restated Balance Sheet Restated Balance Sheet Forecasted Restated Balance Sheet
(in millions) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
ASSETS
Current assets
Cash and cash equivalents 177
172
232
293
192
182
Receivables, net 481
463
460
411
435
460
Inventories, net 252
264
301
323
292
309
Other current assets 83
46
50
63
88
81
51
6
Total current assets 1,044 951 1,043 1,090 1,007
1,032 1,084 1,116 1,150 1,184 1,220 1,256 1,294 1,333 1,373 1,414
Property, plant and equipment, net 992 1,072 1,052
999 1,004
976
968
961
953
946
939
931
924
917
910
902
Adjusted Goodwill 728
584
469
375
301
258
210
170
139
113
92
74
61
49
40
33
Trademarks and other intangible assets, net 573
651
633
599
604
613
Other assets 187
248
364
186
257
190
Total non-current assets 2,480 2,555 2,518 2,159 2,166 2,037
Total assets 3,524 3,506 3,561 3,249 3,173 3,069 2,959 3,112 3,274 3,445 3,624 3,812 4,010 4,219 4,438 4,669
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities
Notes and loans payable 330
361
289
359
156
74
Current maturities of long-term debt 2
213
2
2
152
500
Accounts payable 330
312
310
347
329
329
Accrued liabilities 510
537
643
614
474
507
Income taxes payable 54
28
24
26
19
17
Total current liabilities 1,226 1,451 1,268 1,348 1,130 1,427
856
882
908
935
963
992 1,022 1,053 1,084 1,117
Long-term debt 678
495
475 2,122 1,966
1,462
Other liabilities 231
376
377
618
547
516
Deferred income taxes 23
115
174
82
129
90
Total liabilities 2,158 2,437 2,294 4,170 3,772 3,495 4,035 4,896 5,825 6,825 7,899 9,052 10,287 11,610 13,024 14,534
Stockholders' equity (deficit)
Common Stock 250
250
250
250
250
159
Additional paid-in capital 222
255
301
328
397
481
Initial retained earnings 2,270 2,565 2,846 3,684 3,939 185
568
970 1,392 1,836 2,302 2,792 3,306 3,846 4,414 5,010
Retained earnings adjusted to goodwill impairment -
146
273
368
443
597
651
707
767
829
895
964 1,037 1,114 1,195 1,279
Restated retained earnings 2,270 2,419 2,573 3,316 3,496 (412)
(83)
263
625 1,007 1,407 1,827 2,269 2,732 3,219 3,731
Treasury shares, at cost (1,070) (1,507)
(1,570)
(4,463)
(4,527)
(445)
Accumulated other comprehensive net losses (296)
(339)
(274)
(336)
(215)
(209)
Unearned compensation (10)
(9)
(13)
(16)
Stockholders' equity (deficit) 1,366 1,069 1,267 (921)
(599)
(426) (1,077)
(1,784)
(2,551)
(3,380)
(4,275)
(5,240)
(6,277)
(7,391)
(8,585)
(9,865)
Total liabilities and stockholders' equity (deficit) 3,524 3,506 3,561 3,249 3,173 3,069 2,959 3,112 3,274 3,445 3,624 3,812 4,010 4,219 4,438 4,669
Common Size Restated Balance Sheet Restated Balance Sheet Forecasted Restated Balance Sheet
(in millions) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
ASSETS
Current assets
Cash and cash equivalents 5.02% 4.91% 6.52% 9.02% 6.05% 5.93%
Receivables, net 13.65% 13.21% 12.92% 12.65% 13.71% 14.99%
Inventories, net 7.15% 7.53% 8.45% 9.94% 9.20% 10.07%
Other current assets 2.36% 1.31% 1.40% 1.94% 2.77% 2.64%
1.45% 0.17%
Total current assets 29.63% 27.12% 29.29% 33.55% 31.74% 33.63% 36.63% 35.86% 35.11% 34.38% 33.66% 32.95% 32.26% 31.59% 30.93% 30.28%
Property, plant and equipment, net 28.15% 30.58% 29.54% 30.75% 31.64% 31.80% 32.73% 30.87% 29.12% 27.46% 25.90% 24.43% 23.04% 21.73% 20.49% 19.33%
Adjusted Goodwill 20.66% 16.66% 13.17% 11.54% 9.49% 8.41% 7.09% 5.48% 4.23% 3.27% 2.53% 1.95% 1.51% 1.17% 0.90% 0.70%
Trademarks and other intangible assets, net 16.26% 18.57% 17.78% 18.44% 19.04% 19.97%
Other assets 5.31% 7.07% 10.22% 5.72% 8.10% 6.19%
Total non-current assets 70.37% 72.88% 70.71% 66.45% 68.26% 66.37%
Total assets 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities
Notes and loans payable 9.36% 10.30% 8.12% 11.05% 4.92% 2.41%
Current maturities of long-term debt 0.06% 6.08% 0.06% 0.06% 4.79% 16.29%
Accounts payable 9.36% 8.90% 8.71% 10.68% 10.37% 10.72%
Accrued liabilities 14.47% 15.32% 18.06% 18.90% 14.94% 16.52%
Income taxes payable 1.53% 0.80% 0.67% 0.80% 0.60% 0.55%
Total current liabilities 34.79% 41.39% 35.61% 41.49% 35.61% 46.50% 28.93% 28.33% 27.74% 27.16% 26.59% 26.03% 25.49% 24.96% 24.43% 23.92%
Long-term debt 19.24% 14.12% 13.34% 65.31% 61.96% 47.64%
Other liabilities 6.56% 10.72% 10.59% 19.02% 17.24% 16.81%
Deferred income taxes 0.65% 3.28% 4.89% 2.52% 4.07% 2.93%
Total liabilities 61.24% 69.51% 64.42% 128.35% 118.88% 113.88% 136.39% 157.32% 177.90% 198.13% 217.98% 237.45% 256.52% 275.19% 293.44% 311.28%
Stockholders' equity (deficit)
Common Stock 7.09% 7.13% 7.02% 7.69% 7.88% 5.18%
Additional paid-in capital 6.30% 7.27% 8.45% 10.10% 12.51% 15.67%
Initial retained earnings 64.42% 73.16% 79.92% 113.39% 124.14% 6.03% 19.19% 31.16% 42.52% 53.30% 63.53% 73.23% 82.44% 91.17% 99.45% 107.30%
Retained earnings adjusted to goodwill impairment 4.16% 7.67% 11.33% 13.96% 19.45% 22.00% 22.72% 23.42% 24.08% 24.70% 25.30% 25.86% 26.40% 26.91% 27.40%
Restated retained earnings 64.42% 69.00% 72.25% 102.06% 110.18% -13.42% -2.80% 8.44% 19.10% 29.22% 38.82% 47.93% 56.57% 64.76% 72.53% 79.90%
Treasury shares, at cost -30.36% -42.98% -44.09% -
137.37% -
142.67% -14.50%
Accumulated other comprehensive net losses -8.40% -9.67% -7.69% -10.34% -6.78% -6.81%
Unearned compensation -0.28% -0.26% -0.37% -0.49%
Stockholders' equity (deficit) 38.76% 30.49% 35.58% -28.35% -18.88% -13.88% -36.39% -57.32% -77.90% -98.13% -
117.98% -
137.45% -
156.52% -
175.19% -
193.44% -
211.28%
Total liabilities and stockholders' equity (deficit) 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Statement of Cash Flows
The statement of cash flows is the hardest and most unreliable
financial statement to forecast. It must be forecast to show the expected
cash flows coming from operations, and more importantly in a valuation,
the expected dividends paid. We were able to forecast Clorox’s net cash
from operations, net cash used for investing activities, and the cash
dividends paid for the next ten years. To forecast the net cash from
operations we used the CFFO/Sales ratio. This ratio is cash flows from
operation divided by sales. It was the most consistent cash flow ratio
staying around 0.20 from 2003 to 2005. In 2006 it dropped to 0.11, but
began climbing again in 2007 to 0.15. We decided to use a CFFO/Sales
ratio of 0.18, because we felt that the 2006 ratio was inconsistent with the
other years, and Clorox’s CFFO/Sales ratio was likely to keep climbing. By
multiplying this ratio by sales we were able to obtain the net operating
cash flows for the next ten years.
To find the cash flows used for investing we used the change in property,
plant, and equipment. Clorox is unlikely to acquire new businesses on a
consistent basis, so we felt property, plant, and equipment was a better
benchmark for their investing activities. By seeing if the PPE goes up or
down we can determine if any investing has happened for the year. If PPE
goes up, then there must have been some investing to raise the capital to
purchase it. If PPE goes down the cash flows from investing will be
positive.
To forecast the dividends payout we used an average increase of 5.5% in
dividends per year. Although, there has been years with much higher
percent increases in dividends, they were not the norm and so they were
not used. In 2003, there was an increase of about 23% and in 2007 and
increase of 29% in dividends. Usually the dividends increase by around
3.75% to 7% when they are changed. So we felt 5.5% would accurately
describe this trend.
144
Statement of Cash Flows Actual Statement of Cash Flows Forecasted Statement of Cash Flows
(in millions) 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Operating activities:
Net earnings 493 549 1,096 444 501 576 606 637 670 705 742 781 821 864 909
Deduct: Earnings from discontinued operations
579 1 5
Earnings from continuing operations 461 490 517 443 496
net cash provided by continuing operations:
Depreciation and amortization 189 195 183 188 192
Share-based compensation
11 77 49
Deferred income taxes 98 26 (45) (28) (15)
Restructuring and asset impairment activities 30 11 38 - 13
Gain on exchange of Henkel Iberica, S.A. - - (20) - -
Net loss on disposition of assets (4) 5
Other 36 29 41 44 17
Changes in:
Receivables, net 19 8 33 (29) (15)
Inventories, net (10) (37) (17) 26 (8)
Other current assets (1) - 5 (11) 13
Accounts payable and accrued liabilities (44) 72 54 (50) (30)
Income taxes payable 41 86 22 15 7
Settlement of income tax contingencies (Note 19) - - (94) (151) -
Pension contributions to qualified plans (55) (41) - (10) (10)
Net cash provided by continuing operations 760
844
728
514
709
Net cash provided by discontinued operations 43
55
37
8
-
Net cash provided by operations 803
899
765
522
709
921
969
1,020
1,073
1,128
1,187
1,249
1,314
1,382
1,454
145
Statement of Cash Flows Actual Statement of Cash Flows Forecasted Statement of Cash Flows
(in millions) 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Investing activities:
Capital expenditures (203)
(170)
(151)
(180)
(147)
Businesses acquired -
(13)
-
(16)
(123)
contract (Note 8)
-
41
-
Proceeds from the sale of businesses 15
-
Low-income housing contributions (15)
(17)
Other 2
(34)
(3)
(6)
2
Net cash used for investing by continuing operations (201)
(234)
operations 8
(2)
Net cash used for investing activities (193)
(236)
(154)
(161)
(268)
(8)
(8)
(7)
(7)
(7)
(7)
(7)
(7)
(7)
(7)
Financing activities:
Notes and loans payable, net 30
(75)
68
(204)
(87)
Long-term debt borrowings 8
8
1,635
-
-
Long-term debt repayments (27)
(215)
-
(29)
(150)
Proceeds from option exercise pursuant to Venture Agreement
(Note 12) -
-
133
-
-
Treasury stock acquired from related party, Henkel KGaA (Note 2)
-
(65)
(2,119)
-
-
Treasury stock purchased from non-affiliates (486)
(155)
(160)
(135)
(155)
Cash dividends paid (193)
(229)
(201)
(173)
(183)
(193)
(204)
(215)
(227)
(239)
(252)
(266)
(281)
(296)
(313)
Issuance of common stock for employee stock plans and other 41
111
92
79
119
Other -
24
Net cash used for financing by continuing operations (627)
(596)
operations 10
(9)
Net cash used for financing activities (617)
(605)
(552)
(462)
(456)
146
Common Size Statement of Cash Flows Actual Statement of Cash Flows Forecasted Statement of Cash Flows (in millions) 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Operating activities: Net earnings 61.39% 61.07% 143.27% 85.06% 70.66% 62.50% 62.50% 62.50% 62.50% 62.50% 62.50% 62.50% 62.50% 62.50% 62.50% Deduct: Earnings from discontinued operations
75.69% 0.19% 0.71%
Earnings from continuing operations
57.41% 54.51% 67.58% 84.87% 69.96%
Adjustments to reconcile earnings from continuing operations to
net cash provided by continuing operations:
Depreciation and amortization
23.54% 21.69% 23.92% 36.02% 27.08%
Share-based compensation 1.44% 14.75% 6.91% Deferred income taxes 12.20% 2.89% -5.88% -5.36% -2.12% Restructuring and asset impairment activities
3.74% 1.22% 4.97% 1.83%
Gain on exchange of Henkel Iberica, S.A.
-2.61%
Net loss on disposition of assets
-0.50% 0.56%
Other 4.48% 3.23% 5.36% 8.43% 2.40% Changes in: Receivables, net 2.37% 0.89% 4.31% -5.56% -2.12% Inventories, net -1.25% -4.12% -2.22% 4.98% -1.13% Other current assets -0.12% 0.00% 0.65% -2.11% 1.83% Accounts payable and accrued liabilities
-5.48% 8.01% 7.06% -9.58% -4.23%
Income taxes payable 5.11% 9.57% 2.88% 2.87% 0.99% Settlement of income tax contingencies (Note 19)
-12.29% -28.93%
Pension contributions to qualified plans
-6.85% -4.56% -1.92% -1.41%
Net cash provided by continuing operations
94.65% 93.88% 95.16% 98.47% 100.00%
Net cash provided by discontinued operations
5.35% 6.12% 4.84% 1.53%
Net cash provided by operations
100.00% 100.00% 100.00% 100.00% 100.00%100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
147
Common Size Statement of Cash Flows Actual Statement of Cash Flows Forecasted Statement of Cash Flows (in millions) 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Investing activities:
Capital expenditures 105.18% 72.03% 98.05% 111.80% 54.85%
Businesses acquired 5.51% 9.94% 45.90%
Proceeds from termination of investment in life insurance
contract (Note 8) -25.47%
Proceeds from the sale of businesses
-7.77%
Low-income housing contributions
7.77% 7.20%
Other -1.04% 14.41% 1.95% 3.73% -0.75%
Net cash used for investing by continuing operations
104.15% 99.15%
Net cash (used for) provided by investing by discontinued
operations -4.15% 0.85%
Net cash used for investing activities
100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Financing activities:
Notes and loans payable, net
-4.86% 12.40% -12.32% 44.16% 19.08%
Long-term debt borrowings -1.30% -1.32% -296.20%
Long-term debt repayments 4.38% 35.54% 6.28% 32.89%
Proceeds from option exercise pursuant to Venture Agreement
(Note 12) -24.09%
Treasury stock acquired from related party, Henkel KGaA (Note 2)
10.74% 383.88%
Treasury stock purchased from non-affiliates
78.77% 25.62% 28.99% 29.22% 33.99%
Cash dividends paid 31.28% 37.85% 36.41% 37.45% 40.13%
Issuance of common stock for employee stock plans and other
-6.65% -18.35% -16.67% -17.10% -26.10%
Other -3.97%
Net cash used for financing by continuing operations
101.62% 98.51%
Net cash (used for) provided by financing by discontinued
operations -1.62% 1.49%
Net cash used for financing activities
100.00% 100.00% 100.00% 100.00% 100.00%
148
Valuation Analysis
The purpose of this analysis is to figure out the real value of a firm.
There are two ways of going about finding the value of a firm. These two
methods include the Methods of Comparables and the Intrinsic Valuation
Methods. Both of these methods are broken up into subgroups. These
methods aren’t based on solid financial theory and have no basis for true
numbers. However, they still give an analyst a good idea of what a firm is
worth. And the method of comparables includes the Price/Earnings
(trailing), Price/Earnings (forecast), Price/Book, Dividends/Price, PEG,
Price/EBITDA, Price/Free cash flows, and the Enterprise value. The
intrinsic valuation method uses the Discounted Dividends Valuation,
Residual Income Valuation, Discounted Free Cash Flows Valuation, AEG,
and Long Run Residual Income mode.
Method of Comparables
The methods of comparables are used by analysts to value a
company in their opinion. The reason we say opinion is because they use
numbers that have no room for interpretation. These ratios give a
suggested share price for the company. This per share price compared to
the actual share price lets us know if the firm is fairly valued, overvalued,
or undervalued. The valuation models that are going to be used are the
Price/Earnings (trailing), Price/Earnings (forecast), Price/Book,
Dividend/Price, P.E.G., Price/EBITDA, Price/Free Cash Flows, and the
Enterprise Value/EBITDA ratios.
149
Price/Earnings (Trailing)
The price to equity ratio is the sum of a firm’s price-to-earnings. This
ratio is calculated by dividing the current stock price by the trailing
earnings per share for the past 12 months. This P/E measure is the most
widely used because it is based on actual earnings, which makes it the
most accurate. This ratio is calculated by dividing the current share price
by the trailing 12 months’ earnings per share. From the table below, you
can see that Clorox’s P/E (Trailing) should be $61.14 and $58.80
(restated). When the stated PPS is $57.13, Clorox is undervalued.
P/E (Trailing) P/E Clorox's PPS
Colgate-Palmolive 22.57 Model 61.14
Johnson-Johnson 16.12 Restated 58.80
Procter-Gamble 19.20 Stated 57.13
Average 19.29
Price/Earnings (Forecast)
The price to earnings ratio (forecast) is a measure of the price to
earnings ratio using forecasted earnings from the P/E calculation. This
ratio is used to compare current earnings to estimated future earnings. If
150
the earnings are expected to grow in the future, the forecasted P/E will be
lower than the current P/E. This ratio can also be used in comparing one
company to another in a forward looking manner. To calculate this ratio
you divide the market price per share by the expected earnings per share.
The table shows that from the model Clorox has a value of $59.85 and
$48.01 (restated). With a stated price of $57.13, Clorox is undervalued
with the model and overvalued with the restated prices.
P/E (Forecast) P/E Clorox's PPS
Colgate-Palmolive 16.68 Model 59.85
Johnson-Johnson 13.81 Restated 48.01
Procter-Gamble 16.77 Stated 57.13
Average 15.75
Price/Book
The price to book ratio, also known as the price to equity ratio, is
used to compare the market value of a stock to its book value. This ratio is
calculated by dividing the stocks current closing price by the latest
quarter’s book value per share. Clorox has a negative book value per
share, which makes this method of comparable not applicable.
Dividend/Price
The dividend to price ratio, also known as the dividend yield, is a
financial ratio that shows how much a company pays in dividends each
151
year relative to its share price. This measures how much cash flow you are
getting for every dollar invested in an equity position. To find the PPS for
Clorox, you must take their dividends per share and divide it by the
industry average of the D/P. From this model, we have found that Clorox’s
price per share should be $64.78 and it is stated that their PPS is $57.13.
This ultimately means that their PPS is undervalued.
D/P Clorox's PPS
Colgate Palmolive 0.022 Model 64.78
Procter & Gamble 0.024 Stated 57.13
Johnson & Johnson 0.028
Average 0.025
P.E.G.
The PEG ratio is used to determine a stock’s value while taking into
account the earnings growth. This ratio is used a lot to indicate a stock’s
potential value. This ratio is similar to the P/E ratio in that, a lower PEG
means the more the stock is undervalued. To find the PEG, you must
multiply the industry average by the Earnings Growth Rate. In the chart
below you can see that, from this model, the PPS should be $59.95 and the
stated is $57.13. This again makes the firm undervalued.
152
PEG Ratio
PEG Clorox's PPS
Colgate Palmolive 1.61 Model 59.95
Procter & Gamble 1.60 Restated 54.35
Johnson & Johnson 1.76 Stated 57.13
Average 1.66
Price/Earnings Before Interest, Taxes, Depreciation, and
Amortization
The price to EBITDA is calculated by dividing the current market cap
rate by the Earnings Before Interest, Taxes, Depreciation, and
Amortization. To get the suggested share price for Clorox, we take the
industry average of Johnson and Johnson, and Procter and Gamble,
excluding Colgate-Palmolive because of their abnormally large P/EBITDA.
We then multiply that by the EBITDA for Clorox. After we get this answer,
we divide this number by the number of shares outstanding. From the
model we have derived the suggested share price to be $4.07, which is
means that Clorox is overvalued with a stated price of $57.13.
P/EBITDA P/EBITDA Clorox PPS
Colgate-Palmolive 3.48 Model 4.07
Johnson-Johnson 21.62 Stated 57.13
Procter-Gamble 3.30
153
Average 3.39
P/FCF
The price to free cash flow ratio compares a company’s market price
to its annual level of free cash flow. This is very similar to the price to cash
flow measure but it uses the stricter measure of free cash flow, which
reduces operating cash flows by capital expenditures. This ratio is
exercised mainly when a firm needs to maintain or expand their asset
bases. To find the P/FCF for Clorox you must find the FCF for each firm.
This is done by taking their Cash flows from operations and
adding/subtracting the Cash flow from investing activities. Then you take
that average of those and multiply it by Clorox’s FCF to find the PPS. In
general, the higher this ratio is the more expensive the company is. From
this model we derived that Clorox’s PPS should be stated as $56.64, but it
is stated at $57.13. This in turn means that the firm is overvalued.
PPS Mkt Cap FCF P/FCF
Colgate-Palmolive 68.44 34754.52 1675.40 20.74
Proctor & Gamble 62.86 191723.00 10952.00 17.51
Johnson & Johnson 64.72 182510.40 9110.00 20.03
Industry Avg. 19.43
Clorox Stated 57.13 8641.28 441.00 19.59
Clorox Model 56.64
overvalued
154
Enterprise Value/EBITDA
The enterprise value to EBITDA, also know as enterprise multiple, is
another ratio to value a firm. This ratio basically looks at a firm the way
that a potential acquirer would, because it takes debt into account; not like
any of the other ratios. This ratio is calculated by first finding the
enterprise value. EV is calculated by taking the market cap rate plus book
value of liabilities minus short term investments and cash. Then you find
the industry average of EV/EBITDA and multiply that by EBITDA. That
number must be divided by the number of shares outstanding to get the
suggested share price. Generally, the lower the value is the more likely the
company is undervalued. As you can see in the table below, we derived
that the PPS from this ratio for Clorox should be $37.65, but the stated PPS
is $57.13 which means the firm is overvalued.
EV/EBITDA PPS
Colgate-Palmolive 11.53 68.44
Proctor & Gamble 11.51 62.86
Johnson & Johnson 9.77 64.72
Industry AVG 10.93
Clorox Stated Price 13.67 57.13
Clorox Model Price 37.65
155
Intrinsic Valuations
Discounted Dividends Model
The discounted dividend model is a procedure for valuing the price of
a stock by using predicted dividends and discounting them back to present
value. Generally, if the value obtained by the DDM model is higher than
what the shares are currently trading at, then the stock is undervalued.
This model has the lowest explanatory power of all the intrinsic evaluation
models. It is very close to impossible to value a company based on their
forecasted future dividends because dividends are subject to change
regularly and are very tough to forecast with reasonable accuracy.
Once we figured out the dividends per share for Clorox from 2008
through 2017, we had to discount them back to June 1, 2007, which it
price in time zero money. We used our Ke as our discount rate. We
calculated our total present value of year by year DPS to be $12.29. This
number was calculated by adding up the PV of the DPS from 2007-2017.
Once we have calculated the present value of the year by year DPS,
we then had to calculate the present value of the terminal value perpetuity,
which starts in the year 2018. We then had to discount this value back to
year zero dollars. Then we had to add this value to the present value of
the year by year dividends per share. We used a DPS value of 2.18 for the
perpetuity and after discounting it back to time zero, we found the present
value of the terminal value of perpetuity to be $62.71.
To get the time consistent price, we have to take the future value of
the initial share price, which will give us the price as of June 30, 2007. We
156
then had to multiply this number by 1+Ke to the (11/12) power. This is
because we needed the price as of June 1, 2008.
Discounted Dividends Model
Growth Rate
Ke 0% 2% 4% 6% 8%
3.32% 64.07 138.03 N/A N/A N/A
4.62% 45.78 69.68 247.79 N/A N/A
5.93% 35.54 46.62 80.69 N/A N/A
7.23% 29.09 35.21 48.90 107.12 N/A
8.53% 24.65 28.38 35.38 53.47 208.08
9.84% 21.40 23.81 27.87 36.16 62.47
11.14% 18.95 20.59 23.15 27.71 38.06
Undervalued > $66
Fairly Valued 15% of Observed Price
Overvalued < $49
Observed Price $57.13
157
The chart above shows the sensitivity analysis of the Discounted
Dividend Model. When we used the Ke of 7.23% and a 0% growth rate,
we found our estimated price per share to be $29.09. As you can see from
the chart above, the growth rates have an effect on dividends because of
the effect they have on the terminal value of perpetuity. Over all this
model shows that Clorox is an undervalued firm with a value of $79.95.
Residual Income Model
The Residual income model is the most reliable intrinsic valuation
method with an explanatory power of up to 90%. This model allows us to
value a company based on the current book value of equity, plus the
present value of the value added to the firm. This added or destroyed
value to the firm can be calculated by taking the previous year’s net
income and then subtracting the benchmark. The benchmark is calculated
by multiplying the cost of equity by the previous year’s book value of
equity. If the firm shows that their current net income is less than the
benchmark, they are destroying value and would have a negative residual
value. However, if the firm shows that their current net income is more
than the benchmark, they are creating value and have a positive residual
income. This limits the weight of the terminal value of perpetuity and has
a forward looking perspective.
To find the annual normal income for Clorox we had to multiply the
Ke times the previous year’s book value of equity. We then derived the
residual income by subtracting net income by the annual normal income.
158
We then had to find the present value of the year by year residual income.
This is calculated by multiplying the present value factor by the annual
residual income. This allows us to see the total present value of the year
by year residual income by taking the sum of all the PV year by year
residual income. We calculated this value to be $3,950.38 million.
To find the terminal value of the perpetuity we had to multiply year
2017’s residual income by the average growth rate of the annual residual
income. This value was calculated as $597.09 Million. This number must
be discounted back to time zero dollars. This is done by dividing that
number by Ke minus the perpetuity growth rate. Then you divide that
number by one plus Ke to the 10th power to discount it back to time zero
money. This number is calculated to be $4,641.89 Million.
Next we need to find the market value of equity in June 30, 2007.
This is done by adding the book value of equity, total PV of year by year
residual income, and the terminal value of perpetuity. This number turns
out to be $8,166.27 Million. We then find the model price by dividing the
market value of equity by the number of shares outstanding. This number
is calculated to be $53.99
Now we need to find the time consistent price. This is done by
multiplying the model price by 1+Ke to the (11/12) power to bring the
price to June 1, 2008 numbers. This number is derived to be $57.56.
159
Residual Income Model
Growth Rate
Ke 0% -10% -20% -30% -40% -50%
3.32% 152.01
66.84
54.71
49.86
47.25
45.62
4.62% 102.44
56.39
47.75
44.11
42.09
40.82
5.93% 75.06
48.06
41.88
39.14
37.60
36.61
7.23% 58.12
41.41
36.97
34.92
33.73
32.96
8.53% 46.66
35.99
32.81
31.27
30.37
29.78
9.84% 38.41
31.51
29.23
28.10
27.42
26.97
11.14% 32.34
27.82
26.20
25.37
24.86
24.52
Undervalued > $66
Fairly Valued 15% of Observed Price
Overvalued < $49
Observed Price $57.13
160
Residual Income Model
Growth Rate
Ke 0% -10% -20% -30% -40% -50%
3.32% 139.35
58.96
47.52
42.94
40.48
38.94
4.62% 94.21
49.96
41.65
38.15
36.21
34.98
5.93% 69.26
42.75
36.69
34.00
32.48
31.51
7.23% 53.80
36.99
32.53
30.46
29.27
28.50
8.53% 43.33
32.30
28.99
27.41
26.47
25.86
9.84% 35.80
28.39
25.95
24.74
24.01
23.53
11.14% 30.24
25.18
23.36
22.43
21.87
21.49
Undervalued > $66
Fairly Valued 15% of Observed Price
Overvalued < $49
Observed Price $57.13
161
The above chart shows the sensitivity analysis of the residual income
growth model and as we can see, Clorox is mostly overvalued. Our initial
estimate yielded a PPS of $53.80 when using a Ke of 7.23% and a 0%
growth rate. With the residual income model giving us a price of $57.65
(restated) and $60.26, the firm is fairly valued. However, after subjecting
Clorox’s PPS to all estimated Ke and negative growth rates, we find that
the majority of the combinations lead to the company being overvalued.
Discounted Free Cash Flows Model
The discounted free cash flows model estimates the attractiveness of
an investment opportunity. It uses future free cash flow projections and
discounts the back to get the present value. This then is used to evaluate
the potential for investment. If the value derived from this model is higher
than the current cost of investment, the opportunity should be a good one.
First we must find the free cash flow for the firm. This is done by
adding/subtracting CFFI to/from CFFO. We then must find the PV factor by
dividing 1 by 1+Ke to the “t” power. T stands for the year of which you
trying to calculate. Next we must find the year by year PV of the free cash
flows. This is done by adding the free cash flows to the PV factor. With
those numbers in place, we can now find the year by year PV of the free
cash flows, which is $8,152.30 Million.
With all these numbers in place we must find the terminal value of
the perpetuity. This is calculated by multiplying WACC by the previous
year’s free cash flow. This number turned out to be $1,519.20 Million.
162
Now we need to discount this number to time zero dollars by dividing the
previous number by WACC minus the growth rate. Then divide that
number by 1+WACC to the 10th power. This number turns out to be
$55,641.46.
Now we need to find the market value of the assets. This is done by
adding the total PV of the year by year free cash flows, terminal value of
perpetuity, and the book value of debt and equity, which is calculated to be
$60,726.76 Million. Then you take that number and divide it by the
number of shares outstanding to get the model price which is $401.48.
Now you have to bring the $401.48 to the time consistent price by
multiplying it by 1+WACC to the (11/12) power. This number is derived as
$425.19.
163
Discounted Free Cash Flows Model
Growth Rate
WACC 0% 2% 4% 6% 8%
3.61% 241.25
491.69 N/A N/A N/A
4.56% 183.64
298.41 1,232.95 N/A N/A
5.51% 145.99
209.80 442.64 N/A N/A
6.46% 119.48
158.96 262.64 1,267.94 N/A
7.41% 99.81
125.99 182.87 401.13 N/A
8.36% 84.66
102.88 137.81 231.96 1,372.18
9.31% 72.62
85.77 108.82 159.74 366.12
Undervalued > $66
Fairly Valued 15% of Observed Price
Overvalued < $49
Observed Price $57.13
164
Discounted Free Cash Flows Model
Growth Rate
WACC 0% 2% 4% 6% 8%
3.61% 245.33
495.77 N/A N/A N/A
4.56% 187.75
302.52
1,237.06 N/A N/A
5.51% 150.13
213.94
446.79 N/A N/A
6.46% 123.66
163.14
266.82 1,272.12 N/A
7.41% 104.03
130.20
187.09
405.35 N/A
8.36% 88.90
107.12
142.06
236.21
1,376.43
9.31% 76.90
90.05
113.11
164.02
370.40
Undervalued > $66
Fairly Valued 15% of Observed Price
Overvalued < $49
Observed Price $57.13
The chart above show the sensitivity analysis for the discounted free
cash flows. You can see that the model is sensitive to growth rates
because of the effect it has on terminal value of perpetuity. With our time
165
consistent price to be $425.19, the firm is undervalued. Over all, from the
chart it is obvious that the firm is undervalued.
Abnormal Earnings Growth A.E.G.
The abnormal earnings growth model is based on a forward price to
earnings per share ratio. Abnormal earnings are equal to the forecasted
net earnings, plus dividend reinvestment earnings, minus the benchmark or
normal income. Take the previous year’s dividend payment and multiply it
by the Ke to calculate the dividend reinvestment earnings. This will
ultimately give us the “DRIP” income. To get the Cumulative dividend
income you add the net income with the DRIP. To find the AEG year by
year you must deduct the benchmark income. This is done by taking the
previous year’s book value of equity and multiplying it by the Ke, from the
cumulative dividend income.
Once we have figure our AEG year by year we need a check figure to
make sure it is correct. The change in the residual income should be equal
to the same years AEG. As you can see in the chart below, our AEG year by
year and the change in residual income match perfectly.
AEG 2.27 2.43 2.60 2.78 2.98 3.18 3.40 3.64 3.89
Change in
Residual Income 2.27 2.43 2.60 2.78 2.98 3.18 3.40 3.64 3.89
166
To find the total PV of the year by year AEG you must add up all the
PV year by year for the AEG. These numbers are derived by multiplying
the AEG by the PV factor. The value of the PV of the year by year AEG is
$18.87 Million. Now we need to find the terminal value of the perpetuity.
This is calculated by multiplying the pervious years AEG by the Ke. This
number is $4.16 Million. Now this number must be brought back to time
zero dollars. This is done by dividing the previous number by 1+Ke to the
9th power, which turns out to be $30.69.
To get the adjusted income perpetuity you take the sum of core
income perpetuity, total PV of the year by year AEG, and the AGE terminal
value of the perpetuity. This number is calculated to be $625 Million. Now
to get the initial market value of equity, we divide the adjusted income
perpetuity by the Ke which is $8,469.91 Million.
To get the model price we divide the $8,469.91 million by the
number of shares outstanding, which gets us $57.19. Now we can
compute the time consistent price by multiplying the model price by 1+Ke
to the (11/12) power, which is $60.97.
167
AEG Valuation Model
Growth Rate
Ke 0% -10% -20% -30% -40% -50%
3.32% 279.97
183.48
169.74
164.25
161.29
159.45
4.62% 145.12
115.70
110.18
107.84
106.56
105.74
5.93% 89.07
80.14
78.10
77.19
76.68
76.35
7.23% 60.97
59.23
58.77
58.56
58.43
58.35
8.53% 44.81
45.75
46.03
46.17
46.25
46.30
9.84% 34.61
36.49
37.11
37.42
37.61
37.73
11.14% 27.85
29.95
30.70
31.09
31.33
31.48
Undervalued > $66
Fairly Valued 15% of Observed Price
Overvalued < $49
Observed Price $57.13
168
AEG Valuation Model
Growth Rate
Ke 0% -10% -20% -30% -40% -50%
3.32% 258.39 168.36 155.55 150.42 147.66 145.94
4.62% 135.23 106.81 101.48 99.22 97.98 97.19
5.93% 83.74 74.43 72.30 71.36 70.82 70.48
7.23% 57.77 55.33 54.68 54.38 54.21 54.10
8.53% 42.76 42.98 43.05 43.08 43.09 43.11
9.84% 33.24 34.47 34.87 35.08 35.20 35.28
11.14% 26.90 28.44 28.99 29.27 29.44 29.56
Undervalued > $66
Fairly Valued 15% of Observed Price
Overvalued < $49
Observed Price $57.13
In the tables above you can see the sensitivity analysis for AEG
model. The AEG models prices are less sensitive to in the cost of equity
and the growth rates just like the Residual Income model. We use the
negative growth rates because we assume that these companies are
unable to outperform their cost of equity. With the price from the model
being $60.97, Clorox is fairly valued.
Long Run Residual Income Model
The long run residual income model is another valuation model that
we used. To find the long run residual income model, or LI RI, we had to
find the long run average return on equity, or ROE. We obtained the ROE
169
by averaging the past five years ROE’s and came up with -49.8%. The
reason we came up with a negative number is because Clorox has a
negative book value of equity. The negative ROE made this valuation
method nearly useless. After we found the ROE we needed the cost of
equity, 7.23%, the forward earnings growth rate, 11.25% and 10.2%
restated, and the initial book value of equity, $171 million. Once these
variables are known the following equation is used to find the market value
of equity.
MVE = Book Value of Equity* (1+ ROE-Ke ) Ke - g
After we obtained the market value of equity we had to divide it by the
total number of shares outstanding. This gave us a share price of $17.17
on 6/30/2007. The final share price on 6/1/2008 was $18.30, and a
restated price of $1.34. This model shows Clorox’s stock price to be
severely overstated, but because of the negative ROE we did not value this
estimation too much. Below is the sensitivity analysis for the LR RI model.
170
Long Run Residual Income Model Actual
Initial BE 171 Average ROE -49.80% Ke 7.23% Forward Earnings Growth 11.25% 6/30/2007 Estimated MVE 2,596.90 Number of Shares 151.26 Initial Share Price (6/30/07) 17.17 Time consistent Price (6/01/08) 18.30
Long Run Residual Income Model Restated
Initial BE 171 Average ROE 6.90% Ke 7.23% Forward Earnings Growth 10.20% 6/30/2007 Estimated MVE 190.00 Number of Shares 151.26 Initial Share Price (6/30/07) 1.26 Time consistent Price (6/01/08) 1.34
171
LI RI Model (Actual) Growth Rate
Ke 9% 10% 11% 12% 13%
3.32% 12.06
10.43
9.22
8.29
7.56
4.62% 15.82
13.10
11.23
9.87
8.83
5.93% 22.83
17.51
14.29
12.13
10.59
7.23% 40.04
26.02
19.44
15.62
13.12
8.53% 152.46
49.57
30.00
21.70
17.12
9.84% N/A 460.50
64.58
35.25
24.49
11.14% N/A N/A N/A 89.50
42.05
ROE held constant -49.8% Overvalued < $49 Fairly Valued 15% of Observed Price Undervalued > $66
Observed Price $57.13
172
LI RI Model (Actual) ROE
Ke 0% 5% 10% 15% 20%
3.32% 1.65
0.92
0.18 N/A N/A
4.62% 2.00
1.11
0.22 N/A N/A
5.93% 2.52
1.40
0.28 N/A N/A
7.23% 3.37
1.87
0.37 N/A N/A
8.53% 5.04
2.80
0.56 N/A N/A
9.84% 9.83
5.46
1.09 N/A N/A
11.14% 127.38
70.76
14.15 N/A N/A
Growth held constant at 11.25% Overvalued < $49 Fairly Valued 15% of Observed Price Undervalued > $66
Observed Price $57.13
LI RI Model (Actual) ROE
G 0% 5% 10% 15% 20%
9.00% 6.13
2.72 N/A N/A N/A
10.00% 4.35
2.18 N/A N/A N/A
11.00% 3.52
1.92
0.32 N/A N/A
12.00% 3.03
1.77
0.51 N/A N/A
13.00% 2.72
1.67
0.63 N/A N/A
Ke held constant at 7.23% Overvalued < $49 Fairly Valued 15% of Observed Price Undervalued > $66
Observed Price $57.13
173
LI RI Model (Restated) Growth Rate
Ke 9% 10% 11% 12% 13%
3.32% 0.43
0.54
0.62
0.68
0.73
4.62% 0.56
0.68
0.76
0.81
0.86
5.93% 0.82
0.91
0.96
1.00
1.03
7.23% 1.43
1.35
1.31
1.29
1.27
8.53% 5.44
2.57
2.02
1.79
1.66
9.84% N/A 23.87
4.35
2.91
2.38
11.14% N/A N/A N/A 7.39
4.08
ROE held constant at 6.9% Overvalued < $49 Fairly Valued 15% of Observed Price Undervalued > $66
Observed Price $57.13
174
LI RI Model (Restated) ROE
Ke 0% 5% 10% 15% 20%
3.32% 1.73
0.88
0.03 N/A N/A
4.62% 2.15
1.10
0.04 N/A N/A
5.93% 2.85
1.45
0.06 N/A N/A
7.23% 4.14
2.11
0.08 N/A N/A
8.53% 7.44
3.79
0.15 N/A N/A
9.84% 34.91
17.80
0.68 N/A N/A
11.14% N/A N/A N/A 6.36
12.98
Growth held constant at 10.2% Overvalued < $49 Fairly Valued 15% of Observed Price Undervalued > $66
Observed Price $57.13
LI RI Model (Restated) ROE
G 0% 5% 10% 15% 20%
9.00% 6.13
2.72 N/A N/A N/A
10.00% 4.35
2.18 N/A N/A N/A
11.00% 3.52
1.92
0.32 N/A N/A
12.00% 3.03
1.77
0.51 N/A N/A
13.00% 2.72
1.67
0.63 N/A N/A
Ke held constant at 7.23% Overvalued < $49 Fairly Valued 15% of Observed Price Undervalued > $66
Observed Price $57.13
175
Appendices
Current Ratio
2002 2003 2004 2005 2006 2007
Clorox 0.85 0.66 0.82 0.81 0.89 0.72
Procter-Gamble 0.96 1.23 0.77 0.81 1.22 0.78
Colgate-Palmolive 1.04 1.02 1.00 1.01 0.95 1.14
Johnson-Johnson 1.68 1.71 1.96 2.49 1.20 1.51
Industry Average 1.13 1.15 1.14 1.28 1.06 1.04
Quick Asset Ratio
2002 2003 2004 2005 2006 2007
Clorox 0.54 0.44 0.55 0.52 0.55 0.45
Procter-Gamble 0.53 0.75 0.45 0.49 0.68 0.40
Colgate-Palmolive 0.61 0.61 0.60 0.60 0.58 0.67
Johnson-Johnson 1.12 1.20 1.42 1.83 0.67 0.95
Industry Average 0.70 0.75 0.75 0.86 0.62 0.61
Accounts Receivable Turnover 2002 2003 2004 2005 2006 2007
Clorox 8.36 8.95 9.05 10.68 10.68 10.54
Procter-Gamble 13.02 14.28 12.66 13.56 11.92 11.54
Colgate-Palmolive 8.117 8.1039 8.02 8.71 8.04 8.2
Johnson-Johnson 6.72 6.37 6.93 7.21 6.12 6.47
Industry Average 9.05 9.43 9.17 10.04 9.19 9.19
176
Days Sales Outstanding 2002 2003 2004 2005 2006 2007
Clorox 43.66 40.78 40.33 34.18 34.18 34.63
Procter-Gamble 28.03 25.56 28.83 26.92 30.62 31.63
Colgate-Palmolive 44.97 45.04 45.5 41.9 45.4 44.51
Johnson-Johnson 54.32 57.3 52.67 50.62 59.64 56.41
Industry Average 42.75 42.17 41.83 38.41 42.46 41.80
Inventory Turnover 2002 2003 2004 2005 2006 2007
Clorox 9.04 8.43 7.74 7.72 9.2 8.92
Procter-Gamble 6.07 6.08 5.7 5.55 5.27 5.38
Colgate-Palmolive 6.29 6.21 5.61 6.1 5.5 5.16
Johnson-Johnson 3.16 3.39 3.58 3.52 3.08 3.47
Industry Average 6.14 6.03 5.66 5.72 5.76 5.73
Days Supply of Inventory 2002 2003 2004 2005 2006 2007
Clorox 40.38 43.3 47.16 47.28 39.67 40.92
Procter-Gamble 60.13 60.03 64.04 65.77 69.26 67.84
Colgate-Palmolive 58.03 58.78 65.06 59.84 66.36 70.74
Johnson-Johnson 115.51 107.67 101.95 103.69 118.51 105.19
Industry Average 68.51 67.45 69.55 69.15 73.45 71.17
177
Working Capital Turnover
2003 2004 2005 2006 2007
Clorox 3.28 2.70 ‐7.93 ‐29.77 28.35
Clorox Restated 3.73 3.28 ‐4.76 ‐7.75 ‐11.38
Colgate Palmolive 11.16 8.50 8.44 8.67 6.03
Proctor & Gamble 2.70 2.98 3.25 1.08 1.15
Johnson & Johnson 1.56 1.49 1.33 1.36 1.41
Industry Average 4.49 3.79 0.06 ‐5.28 5.11
Cash to Cash Cycle
2002 2003 2004 2005 2006 2007
Clorox 84.04 84.08 87.49 81.46 73.85 75.55
Procter‐Gamble 88.16 85.59 92.87 92.69 99.88 99.47
Colgate‐Palmolive 103 84.34 110.56 101.74 111.76 115.25
Johnson‐Johnson 169.83 164.97 154.62 154.31 178.15 161.6
Industry Average 111.26 104.75 111.39 107.55 115.91 112.97
Gross Profit Margin
2003 2004 2005 2006 2007
Clorox 45.5% 44.0% 43.2% 42.2% 43.1%
Proctor &Gamble 49.0% 51.2% 51.0% 32.0% 52.0%
Johnson & Johnson 70.9% 71.7% 72.3% 71.8% 70.9%
Colgate-Palmolive 55.0% 55.1% 54.4% 54.8% 56.2%
178
Operating Profit Margin 2003 2004 2005 2006 2007
Clorox 20.1% 21.3% 17.9% 16.8% 17.6%
Proctor &Gamble 16.9% 18.3% 18.5% 19.4% 20.2%
Johnson & Johnson 21.7% 27.4% 25.8% 27.1% 23.8%
Colgate-Palmolive 21.9% 20.0% 19.5% 17.7% 19.2%
Net Profit Margin 2003 2004 2005 2006 2007
Clorox 12.4% 13.2% 25.0% 9.6% 10.3%
Proctor &Gamble 11.0% 12.0% 12.2% 12.7% 13.5%
Johnson & Johnson 17.3% 20.7% 19.9% 18.0% 17.2%
Colgate-Palmolive 14.4% 12.5% 11.9% 11.1% 12.6%
Asset Turnover Ratio 2003 2004 2005 2006 2007
Clorox 1.13 1.14 1.14 1.28 1.34
Proctor &Gamble 1.06 1.18 0.99 1.11 0.56
Johnson & Johnson 1.03 0.98 0.87 0.92 0.87
Colgate-Palmolive 1.40 1.42 1.31 1.44 1.51
ROA 2003 2004 2005 2006 2007
Clorox 14.0% 15.0% 28.6% 12.3% 13.9%
Proctor &Gamble 11.7% 14.1% 12.1% 14.1% 7.6%
Johnson & Johnson 17.7% 17.6% 18.9% 19.0% 15.0%
Colgate-Palmolive 20.1% 17.7% 15.6% 15.9% 19.0%
179
ROE 2003 2004 2005 2006 2007
Clorox 0.36 0.45 0.71 -0.80 -3.21
Colgate Palmolive 4.06 1.50 1.08 1.00 1.23
Proctor & Gamble 0.38 0.40 0.42 0.50 0.16
Johnson & Johnson 0.85 0.78 0.33 0.29 0.27
IGR
2003 2004 2005 2006 2007
Clorox 8.2% 8.3% 24.7% 7.5% 8.7%
Colgate 12.9% 9.1% 8.8% 7.4% 9.8%
JNJ 11.0% 10.3% 11.8% 11.7% 8.4%
Proctor 7.6% 8.3% 7.3% 8.1% 4.5%
SGR
2003 2004 2005 2006 2007
Clorox 0.21 0.25 0.62 -1.93 -2.02
Colgate 2.61 0.77 0.61 0.47 0.63
JNJ 0.20 0.19 0.20 0.18 0.15
Proctor 0.23 0.22 0.24 0.27 0.10
180
Z-Score
2003 2004 2005 2006 2007
Clorox 2.93 3.21 3.19 3.45 2.06
Colgate 2.63 2.34 2.54 2.43 2.7
JNJ 2.75 3.14 3.24 2.25 2.24
Proctor 2.46 1.96 1.95 2.18 2.26
Cost of Debt
Cost of Debt Debt Interest Rate Weight WACDCurrent liabilities Notes and loans payable $
74 5.72 2.12% 0.12Current maturities of long-term debt 500 5.49 14.31% 0.79Accounts payable 329 2.03 9.41% 0.19Accrued liabilities 507 2.03 14.51% 0.29Income taxes payable 17 4.06 0.49% 0.02Total current liabilities 1,427 Long-term debt 1,462 5.11 41.83% 2.14Other liabilities 516 5 14.76% 0.74Deferred income taxes 90 4.06 2.58% 0.10Total liabilities 3,495 100.00% 4.39
WACC
Weighted Average Cost of Capital Cost of Debt D/D+E Tax Rate Cost of Equity E/D+E WACC
WACCBT 4.39% 0.27 0 7.23% 0.73 6.46%
WACCAT 4.39% 0.27 35% 7.23% 0.73 4.62%
181
P/E Trailing
P/E (Trailing) P/E Clorox's PPS
Colgate-Palmolive 22.57 Model 61.14
Johnson-Johnson 16.12 Restated 58.80
Procter-Gamble 19.20 Stated 57.13
Average 19.29
P/E Forecast
P/E (Forecast) P/E Clorox's PPS
Colgate-Palmolive 16.68 Model 59.85
Johnson-Johnson 13.81 Restated 48.01
Procter-Gamble 16.77 Stated 57.13
Average 15.75
Dividend/Price
D/P Clorox's PPS
Colgate Palmolive 0.022 Model 64.78
Procter & Gamble 0.024 Stated 57.13
Johnson & Johnson 0.028
Average 0.025
182
P.E.G.
PEG Ratio
PEG Clorox's PPS
Colgate Palmolive 1.61 Model 59.95
Procter & Gamble 1.60 Restated 54.35
Johnson & Johnson 1.76 Stated 57.13
Average 1.66
Price/EBITDA
P/EBITDA P/EBITDA Clorox PPS
Colgate-Palmolive 3.48 Model 4.07
Johnson-Johnson 21.62 Stated 57.13
Procter-Gamble 3.30
Average 3.39
P/FCF
PPS Mkt Cap FCF P/FCF
Colgate-Palmolive 68.44 34754.52 1675.40 20.74
Proctor & Gamble 62.86 191723.00 10952.00 17.51
Johnson & Johnson 64.72 182510.40 9110.00 20.03
Industry Avg. 19.43
Clorox Stated 57.13 8641.28 441.00 19.59
Clorox Model 56.64
overvalued
183
EV/EBITDA
EV/EBITDA PPS
Colgate-Palmolive 11.53 68.44
Proctor & Gamble 11.51 62.86
Johnson & Johnson 9.77 64.72
Industry AVG 10.93
Clorox Stated Price 13.67 57.13
Clorox Model Price 37.65
184
3 month Regressions SUMMARY OUTPUT
Regression Statistics Multiple R 0.379033188 R Square 0.143666158 Adjusted R Square 0.131432817 Standard Error 0.044868901 Observations 72 ANOVA
df SS MS F Significance F Regression 1 0.023642874 0.023642874 11.74382064 0.001025815 Residual 70 0.140925277 0.002013218 Total 71 0.164568151
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.004445384 0.005297415 0.839161035 0.404235667 -0.006119976 0.015010745 -0.006119976 0.015010745X Variable 1 0.52735802 0.153886616 3.42692583 0.001025815 0.220440846 0.834275194 0.220440846 0.834275194
SUMMARY OUTPUT
Regression Statistics Multiple R 0.225310057 R Square 0.050764622 Adjusted R Square 0.034398495 Standard Error 0.037905389 Observations 60 ANOVA
df SS MS F Significance F Regression 1 0.004456738 0.004456738 3.101810296 0.083476072 Residual 58 0.083335472 0.001436818 Total 59 0.087792211
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.005026494 0.004958934 1.013623866 0.31497218 -0.004899891 0.014952879 -0.004899891 0.014952879X Variable 1 0.35301481 0.200440423 1.761195701 0.083476072 -0.048210285 0.754239905 -0.048210285 0.754239905
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.310167436 R Square 0.096203839 Adjusted R Square 0.076556096 Standard Error 0.038347396
Observations 48 ANOVA
df SS MS F Significance F Regression 1 0.007200315 0.007200315 4.896432144 0.031914309 Residual 46 0.067644049 0.001470523 Total 47 0.074844364
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.003381985 0.005552794 0.609060137 0.545480996 -0.007795209 0.01455918 -0.007795209 0.01455918X Variable 1 0.497222574 0.224704085 2.212788319 0.031914309 0.044916718 0.94952843 0.044916718 0.94952843
SUMMARY OUTPUT
Regression Statistics Multiple R 0.366470544 R Square 0.13430066 Adjusted R Square 0.108838915 Standard Error 0.036278414 Observations 36 ANOVA
df SS MS F Significance F Regression 1 0.006942031 0.006942031 5.274605426 0.027924966 Residual 34 0.044748194 0.001316123 Total 35 0.051690226
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.001114969 0.006056287 0.184101061 0.855027823 -0.011192886 0.013422824 -0.011192886 0.013422824X Variable 1 0.556265768 0.242207366 2.296650915 0.027924966 0.064041182 1.048490355 0.064041182 1.048490355
SUMMARY OUTPUT
Regression Statistics Multiple R 0.414036208 R Square 0.171425981 Adjusted R Square 0.133763526 Standard Error 0.036061692 Observations 24 ANOVA
185
df SS MS F Significance F Regression 1 0.005919162 0.005919162 4.551641139 0.044286144 Residual 22 0.028609803 0.001300446 Total 23 0.034528965
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept -0.00218212 0.007366525 -0.29622061 0.769839852 -0.017459355 0.013095122 -0.017459355 0.013095122X Variable 1 0.575809047 0.269894775 2.133457555 0.044286144 0.016081544 1.13553655 0.016081544 1.13553655
6 Month Regressions SUMMARY OUTPUT
Regression Statistics Multiple R 0.379115766 R Square 0.143728764 Adjusted R Square 0.131496318 Standard Error 0.04486726 Observations 72 ANOVA
df SS MS F Significance F Regression 1 0.023653177 0.023653177 11.74979735 0.001023003 Residual 70 0.140914974 0.002013071 Total 71 0.164568151
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.004510186 0.005296115 0.851602662 0.397338703 -0.006052583 0.015072955 -0.006052583 0.015072955X Variable 1 0.527524887 0.153896153 3.427797741 0.001023003 0.220588691 0.834461083 0.220588691 0.834461083
SUMMARY OUTPUT
Regression Statistics Multiple R 0.225225781 R Square 0.050726652 Adjusted R Square 0.03435987 Standard Error 0.037906147 Observations 60 ANOVA
df SS MS F Significance F Regression 1 0.004453405 0.004453405 3.099366314 0.083594704 Residual 58 0.083338806 0.001436876 Total 59 0.087792211
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.005077972 0.004954432 1.024935299 0.309649548 -0.004839401 0.014995345 -0.004839401 0.014995345X Variable 1 0.352875852 0.200440504 1.760501722 0.083594704 -0.048349406 0.75410111 -0.048349406 0.75410111
SUMMARY OUTPUT
Regression Statistics Multiple R 0.31012155 R Square 0.096175376 Adjusted R Square 0.076527014 Standard Error 0.038348 Observations 48 ANOVA
df SS MS F Significance F Regression 1 0.007198185 0.007198185 4.894829339 0.031940999 Residual 46 0.067646179 0.001470569 Total 47 0.074844364
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.003461809 0.005550114 0.623736613 0.535881518 -0.007709991 0.01463361 -0.007709991 0.01463361X Variable 1 0.497283883 0.224768583 2.212426121 0.031940999 0.0448482 0.949719566 0.0448482 0.949719566
186
SUMMARY OUTPUT
Regression Statistics Multiple R 0.366640492 R Square 0.13442525 Adjusted R Square 0.108967169 Standard Error 0.036275804 Observations 36 ANOVA
df SS MS F Significance F Regression 1 0.006948472 0.006948472 5.280258586 0.027846951 Residual 34 0.044741754 0.001315934 Total 35 0.051690226
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.001190121 0.006054063 0.196582238 0.845324831 -0.011113215 0.013493457 -0.011113215 0.013493457X Variable 1 0.556800199 0.24231025 2.297881326 0.027846951 0.064366526 1.049233872 0.064366526 1.049233872
SUMMARY OUTPUT
Regression Statistics Multiple R 0.414420918 R Square 0.171744697 Adjusted R Square 0.134096729 Standard Error 0.036054755 Observations 24
ANOVA
df SS MS F Significance F Regression 1 0.005930167 0.005930167 4.561858322 0.044069458 Residual 22 0.028598798 0.001299945 Total 23 0.034528965
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -
0.002121164 0.007364056 -0.288042844 0.776010112 -0.01739328 0.013150953 -0.01739328 0.013150953 X Variable 1 0.576684771 0.270002376 2.135850726 0.044069458 0.016734117 1.136635424 0.016734117 1.136635424
2 Years
SUMMARY OUTPUT
Regression Statistics Multiple R 0.379024359 R Square 0.143659465 Adjusted R Square 0.131426028 Standard Error 0.044869076 Observations 72 ANOVA
df SS MS F Significance F Regression 1 0.023641772 0.023641772 11.74318173 0.001026116 Residual 70 0.140926378 0.002013234 Total 71 0.164568151
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.004634391 0.005294409 0.875336638 0.384384459 -0.005924976 0.015193757 -0.005924976 0.015193757X Variable 1 0.527265303 0.153863746 3.426832609 0.001026116 0.220393741 0.834136865 0.220393741 0.834136865
187
SUMMARY OUTPUT
Regression Statistics Multiple R 0.223673553 R Square 0.050029858 Adjusted R Square 0.033651063 Standard Error 0.037920056 Observations 60 ANOVA
df SS MS F Significance F Regression 1 0.004392232 0.004392232 3.05455052 0.085803563 Residual 58 0.083399979 0.001437931 Total 59 0.087792211
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.005151801 0.004950627 1.04063617 0.302363031 -0.004757955 0.015061557 -0.004757955 0.015061557X Variable 1 0.351200333 0.200946878 1.747727244 0.085803563 -0.051038542 0.753439209 -0.051038542 0.753439209
SUMMARY OUTPUT
Regression Statistics Multiple R 0.309782647 R Square 0.095965288 Adjusted R Square 0.07631236 Standard Error 0.038352457 Observations 48 ANOVA
df SS MS F Significance F Regression 1 0.007182461 0.007182461 4.883001961 0.032138694 Residual 46 0.067661903 0.001470911 Total 47 0.074844364
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.003503384 0.005549437 0.631304314 0.530966245 -0.007667054 0.014673822 -0.007667054 0.014673822X Variable 1 0.497107077 0.224960618 2.209751561 0.032138694 0.044284846 0.949929309 0.044284846 0.949929309
SUMMARY OUTPUT
Regression Statistics Multiple R 0.367669729 R Square 0.135181029 Adjusted R Square 0.109745177 Standard Error 0.036259963 Observations 36 ANOVA
df SS MS F Significance F Regression 1 0.006987538 0.006987538 5.31458624 0.027378304 Residual 34 0.044702688 0.001314785 Total 35 0.051690226
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.001149723 0.006052303 0.189964604 0.850466495 -0.011150035 0.013449482 -0.011150035 0.013449482X Variable 1 0.558927679 0.242449274 2.305338639 0.027378304 0.066211476 1.051643881 0.066211476 1.051643881
SUMMARY OUTPUT
Regression Statistics Multiple R 0.415566414 R Square 0.172695444 Adjusted R Square 0.135090692 Standard Error 0.036034056 Observations 24 ANOVA
df SS MS F Significance F Regression 1 0.005962995 0.005962995 4.592383481 0.043429188
188
Residual 22 0.02856597 0.001298453 Total 23 0.034528965
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept -0.002208018 0.007361314 -0.299948965 0.767031877 -0.017474449 0.013058412 -0.017474449 0.013058412X Variable 1 0.578844391 0.270111302 2.142984713 0.043429188 0.018667839 1.139020944 0.018667839 1.139020944
5 year
SUMMARY OUTPUT
Regression Statistics Multiple R 0.378458961 R Square 0.143231185 Adjusted R Square 0.130991631 Standard Error 0.044880295 Observations 72 ANOVA
df SS MS F Significance F Regression 1 0.023571291 0.023571291 11.70232017 0.001045569 Residual 70 0.140996859 0.002014241 Total 71 0.164568151
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.004893395 0.005292526 0.924585968 0.358357729 -0.005662215 0.015449005 -0.005662215 0.015449005X Variable 1 0.526307206 0.153852064 3.420865413 0.001045569 0.219458943 0.833155469 0.219458943 0.833155469
SUMMARY OUTPUT
Regression Statistics Multiple R 0.222293949 R Square 0.0494146 Adjusted R Square 0.033025196 Standard Error 0.037932334 Observations 60 ANOVA
df SS MS F Significance F Regression 1 0.004338217 0.004338217 3.015033448 0.087805094 Residual 58 0.083453994 0.001438862 Total 59 0.087792211
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.005294905 0.004941241 1.071573865 0.288350227 -0.004596064 0.015185873 -0.004596064 0.015185873X Variable 1 0.349417323 0.201232612 1.736385167 0.087805094 -0.053393512 0.752228158 -0.053393512 0.752228158
SUMMARY OUTPUT
Regression Statistics Multiple R 0.309635094 R Square 0.095873892 Adjusted R Square 0.076218976 Standard Error 0.038354395 Observations 48 ANOVA
df SS MS F Significance F Regression 1 0.00717562 0.00717562 4.87785827 0.032225084 Residual 46 0.067668743 0.00147106 Total 47 0.074844364
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.003608723 0.00554658 0.650621316 0.518527696 -0.007555963 0.014773409 -0.007555963 0.014773409X Variable 1 0.496056887 0.224603694 2.208587392 0.032225084 0.043953107 0.948160668 0.043953107 0.948160668
SUMMARY OUTPUT
Regression Statistics Multiple R 0.369066251 R Square 0.136209898 Adjusted R Square 0.110804307 Standard Error 0.036238388 Observations 36
189
ANOVA
df SS MS F Significance F Regression 1 0.00704072 0.00704072 5.361414212 0.026752826 Residual 34 0.044649505 0.001313221 Total 35 0.051690226
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.001201495 0.006047462 0.198677613 0.843698223 -0.011088426 0.013491417 -0.011088426 0.013491417X Variable 1 0.559833226 0.24177923 2.315472784 0.026752826 0.068478717 1.051187736 0.068478717 1.051187736
SUMMARY OUTPUT
Regression Statistics Multiple R 0.416651639 R Square 0.173598588 Adjusted R Square 0.136034888 Standard Error 0.036014382 Observations 24 ANOVA
df SS MS F Significance F Regression 1 0.00599418 0.00599418 4.62144533 0.042829364 Residual 22 0.028534785 0.001297036 Total 23 0.034528965
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -
0.002132617 0.007355948 -0.289917322 0.774594433 -0.017387919 0.013122685 -0.017387919 0.013122685 X Variable 1 0.578811745 0.269245482 2.149754714 0.042829364 0.020430793 1.137192697 0.020430793 1.137192697
10 Year SUMMARY OUTPUT
Regression Statistics Multiple R 0.37901563 R Square 0.143652848 Adjusted R Square 0.131419317 Standard Error 0.044869249 Observations 72 ANOVA
df SS MS F Significance F Regression 1 0.023640683 0.023640683 11.74255009 0.001026414 Residual 70 0.140927467 0.00201325 Total 71 0.164568151
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.005295201 0.005288358 1.001294008 0.320133483 -0.005252096 0.015842498 -0.005252096 0.015842498X Variable 1 0.526686983 0.153699118 3.426740447 0.001026414 0.220143763 0.833230203 0.220143763 0.833230203
SUMMARY OUTPUT
Regression Statistics Multiple R 0.2260858 R Square 0.051114789 Adjusted R Square 0.034754699 Standard Error 0.037898396 Observations 60 ANOVA
df SS MS F Significance F Regression 1 0.00448748 0.00448748 3.124358703 0.082390323 Residual 58 0.08330473 0.001436288 Total 59 0.087792211
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.005535713 0.004919331 1.125297977 0.265097942 -0.004311397 0.015382823 -0.004311397 0.015382823
190
X Variable 1 0.353841776 0.200183677 1.767585558 0.082390323 -0.046869387 0.754552938 -0.046869387 0.754552938
SUMMARY OUTPUT
Regression Statistics Multiple R 0.312715159 R Square 0.09779077 Adjusted R Square 0.078177526 Standard Error 0.038313715 Observations 48 ANOVA
df SS MS F Significance F Regression 1 0.007319088 0.007319088 4.985955906 0.03046117 Residual 46 0.067525276 0.001467941 Total 47 0.074844364
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.00393747 0.005533433 0.711578144 0.480319257 -0.007200752 0.015075692 -0.007200752 0.015075692X Variable 1 0.497531032 0.222815786 2.232925414 0.03046117 0.049026123 0.946035941 0.049026123 0.946035941
SUMMARY OUTPUT
Regression Statistics Multiple R 0.370498093 R Square 0.137268837 Adjusted R Square 0.111894391 Standard Error 0.036216168 Observations 36 ANOVA
df SS MS F Significance F Regression 1 0.007095457 0.007095457 5.409727466 0.02612381 Residual 34 0.044594768 0.001311611 Total 35 0.051690226
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.001650942 0.00603705 0.273468341 0.786147634 -0.01061782 0.013919704 -0.01061782 0.013919704X Variable 1 0.556707728 0.239353376 2.325882084 0.02612381 0.070283147 1.043132309 0.070283147 1.043132309
SUMMARY OUTPUT
Regression Statistics Multiple R 0.416547073 R Square 0.173511464 Adjusted R Square 0.135943803 Standard Error 0.03601628 Observations 24 ANOVA
df SS MS F Significance F Regression 1 0.005991171 0.005991171 4.618639023 0.042886875 Residual 22 0.028537794 0.001297172 Total 23 0.034528965
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept -0.001493956 0.007351894 -0.20320702 0.840840974 -0.016740851 0.013752938 -0.016740851 0.013752938X Variable 1 0.571597562 0.265970431 2.149101911 0.042886875 0.02000865 1.123186474 0.02000865 1.123186474
191
Discounted Dividends Approach Ke 0.0723
Perp
Relevant Valuation Item 0 1 2 3 4 5 6 7 8 9 10 11
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Dividends Paid (in millions) 183
193
204
215
227
239
252
266
281
296
313
330
DPS (Dividends Per Share) 1.21
1.28
1.35
1.42
1.50
1.58
1.67
1.76
1.86
1.96
2.07
2.18
PV Factor 1 0.9326 0.8697 0.8111 0.7564 0.7054 0.6578 0.6135 0.5721 0.5335 0.4976 0.4640
Pv of DPS 1.21
1.19
1.17
1.15
1.13
1.12
1.10
1.08
1.06
1.05
1.03
1.01
PV of year-by-year dividends 12.29
TV of Perpetuity 62.70541561 Discounted Dividends Model
Growth Rate
Model Price 74.99 Ke 0% 2% 4% 6% 8%
6/1/2008 79.95 3.32%
64.07
138.03
(223.07)
(45.21)
(19.37)
4.62% 45.78
69.68
247.79
(90.36)
(28.33)
Cost of Equity 0.0723 5.93% 35.54
46.62
80.69
(1,831.95)
(48.67)
Growth Rate 0.055 7.23% 29.09
35.21
48.90
107.12
(137.10)
8.53% 24.65
28.38
35.38
53.47
208.08
0.055 9.84% 21.40
23.81
27.87
36.16
62.47
0.0723 11.14% 18.95
20.59
23.15
27.71
38.06
Undervalued > $66
Fairly Valued 15% of Observed Price
Overvalued < $49
Observed Price $57.13
192
Discounted FCF Model
(in millions) 0 1 2 3 4 5 6 7 8 9 10 11
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Cash Flows from Operations
709
921
969
1,020
1,073
1,128
1,187
1,249
1,314
1,382
1,454 Cash Flows from Investing Activities
(268.00)
(7.61)
(7.55)
(7.49)
(7.44)
(7.38)
(7.32)
(7.26)
(7.21)
(7.15)
(7.09)
Free Cash Flows 441.00
913.70
961.67
1,012.13
1,065.21
1,121.05
1,179.78
1,241.57
1,306.56
1,374.94
1,446.86
1,519.20 5%
PV Factor 0.9393 0.8823 0.8288 0.7785 0.7313 0.6869 0.6452 0.6060 0.5693 0.5347
PV of YBY FCF 858.26
848.51
838.84
829.26
819.77
810.37
801.06
791.84
782.72
773.68
Total PV of YBY FCF 8,154.30
Terminal Value of Perpetuity 55,641.46
0.87
Book Value of Debt and Equity 3069 Discounted Free Cash Flows Model
Market Value of Assets 60,726.76 Growth Rate
WACC 0% 2% 4% 6% 8%
Model Price 401.48 3.61%
245.33
495.77 N/A N/A N/A
Time Consistent Price 425.19 4.56%
187.75
302.52
1,237.06 N/A N/A
5.51% 150.13
213.94
446.79 N/A N/A
WACC 6.46% 6.46% 123.66
163.14
266.82
1,272.12 N/A
Growth Rate 5.00% 7.41% 104.03
130.20
187.09
405.35 N/A
8.36% 88.90
107.12
142.06
236.21
1,376.43
9.31% 76.90
90.05
113.11
164.02
370.40
Undervalued > $66
0.0931 Fairly Valued 15% of Observed Price
193
0.0361 Overvalued < $49
Observed Price $57.13
194
Restated Discounted FCF Model
(in millions) 0 1 2 3 4 5 6 7 8 9 10 11
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Cash Flows from Operations
709
921
969
1,020
1,073
1,128
1,187
1,249
1,314
1,382
1,454 Cash Flows from Investing Activities
(268.00)
(7.61)
(7.55)
(7.49)
(7.44)
(7.38)
(7.32)
(7.26)
(7.21)
(7.15)
(7.09)
Free Cash Flows 441.00
913.70
961.67
1,012.13
1,065.21
1,121.05
1,179.78
1,241.57
1,306.56
1,374.94
1,446.86
1,519.20 5%
PV Factor 0.9393 0.8823 0.8288 0.7785 0.7313 0.6869 0.6452 0.6060 0.5693 0.5347
PV of YBY FCF 858.26
848.51
838.84
829.26
819.77
810.37
801.06
791.84
782.72
773.68
Discounted Free Cash Flows Model
Total PV of YBY FCF 8,154.30 Growth Rate
Terminal Value of Perpetuity 55,641.46
0.87 WACC 0% 2% 4% 6% 8%
Book Value of Debt and Equity 3069 3.61% 245.33
495.77 N/A N/A N/A
Market Value of Assets 60,726.76 4.56%
187.75
302.52
1,237.06 N/A N/A
5.51% 150.13
213.94
446.79 N/A N/A
Model Price 401.48 6.46%
123.66
163.14
266.82
1,272.12 N/A
Time Consistent Price 425.19 7.41%
104.03
130.20
187.09
405.35 N/A
8.36% 88.90
107.12
142.06
236.21
1,376.43
WACC 6.46% 9.31% 76.90
90.05
113.11
164.02
370.40
Growth Rate 5.00% Undervalued > $66
Fairly Valued 15% of Observed Price
Overvalued < $49
Observed Price $57.13
195
Residual Income Model
(in millions) 0 1 2 3 4 5 6 7 8 9 10 Perp.
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Net Income 501.00
575.82
605.77
637.27
670.40
705.27
741.94
780.52
821.11
863.80
908.72
Total Dividends (183.00)
(193.07)
(203.68)
(214.89)
(226.70)
(239.17)
(252.33)
(266.21)
(280.85)
(296.29)
(312.59)
Book Value of Equity 171.00
553.76
955.84
1,378.22
1,821.92
2,288.01
2,777.62
3,291.94
3,832.20
4,399.71
4,995.84
Annual Normal Income 12.36
40.04
69.11
99.65
131.72
165.42
200.82
238.01
277.07
318.10
Annual Residual Income 563.46
565.73
568.16
570.76
573.54
576.52
579.70
583.10
586.74
590.62
593.58
pv factor 0.9326 0.8697 0.8111 0.7564 0.7054 0.6578 0.6135 0.5721 0.5335 0.4976
YBY PV RI 525.47
492.01
460.81
431.71
404.56
379.24
355.62
333.59
313.04
293.86
Residual Income Model
Book Value of Equity 171 Growth Rate
Total PV of YBY RI 3,989.91 Ke 0% -10% -20% -30% -40% -50%
Terminal Value Perpetuity 4388.323323 3.32% 152.01
66.84
54.71
49.86
47.25
45.62
MVE 6/30/2007 8,549.23 4.62%
102.44
56.39
47.75
44.11
42.09
40.82
Divide by Shares 151.256 5.93% 75.06
48.06
41.88
39.14
37.60
36.61
Model Price on 6/30/2007 56.52 7.23%
58.12
41.41
36.97
34.92
33.73
32.96
Time Consistent Price 6/1/2008 60.26 8.53%
46.66
35.99
32.81
31.27
30.37
29.78
9.84% 38.41
31.51
29.23
28.10
27.42
26.97
Observed Share Price 5/30/2008 57.13 11.14%
32.34
27.82
26.20
25.37
24.86
24.52
Cost of Equity 7.23% Undervalued > $66
Perpetuity Growth Rate 0.50% Fairly Valued 15% of Observed Price
Overvalued < $49
Observed Price $57.13
196
Restated Residual Income Model
(in millions) 0 1 2 3 4 5 6 7 8 9 10 Perp.
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Net Income 460.65
522.08
549.23
577.79
607.83
639.44
672.69
707.67
744.47
783.18
823.91
Total Dividends (183.00)
(193.07)
(203.68)
(214.89)
(226.70)
(239.17)
(252.33)
(266.21)
(280.85)
(296.29)
(312.59)
Book Value of Equity (426.00)
(96.98)
248.56
611.46
992.59
1,392.86
1,813.22
2,254.68
2,718.31
3,205.20
3,716.51
Annual Normal Income (30.80)
(7.01)
17.97
44.21
71.76
100.70
131.10
163.01
196.53
231.74
Annual Residual Income 552.88
556.24
559.82
563.62
567.68
571.99
576.58
581.46
586.65
592.17
597.09
pv factor 0.93257 0.86970 0.81106 0.75637 0.70537 0.65781 0.61346 0.57210 0.53352 0.49755
YBY PV RI 515.60
483.76
454.04
426.31
400.42
376.26
353.71
332.65
312.99
294.64
Book Value of Equity (426.00) Residual Income Model
Total PV of YBY RI 3,950.38 Growth Rate
Terminal Value Perpetuity 4641.891042 Ke 0% -10% -20% -30% -40% -50%
MVE 6/30/2007 8,166.27 3.32%
139.35
58.96
47.52
42.94
40.48
38.94
Divide by Shares 151.25646 4.62% 94.21
49.96
41.65
38.15
36.21
34.98
Model Price on 6/30/2007 53.99 5.93%
69.26
42.75
36.69
34.00
32.48
31.51
Time Consistent Price 6/1/2008 57.56 7.23%
53.80
36.99
32.53
30.46
29.27
28.50
8.53% 43.33
32.30
28.99
27.41
26.47
25.86
Observed Share Price 5/30/2008 57.13 9.84%
35.80
28.39
25.95
24.74
24.01
23.53
Cost of Equity 7.23% 11.14% 30.24
25.18
23.36
22.43
21.87
21.49
Perpetuity Growth Rate 0.83% Undervalued > $66
Fairly Valued 15% of Observed Price
Overvalued < $49
197
Observed Price $57.13
198
AEG Valuation
0 1 2 3 4 5 6 7 8 9 10 Perp.
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Net Income 576
606
637
670
705
742
781
821
864
909
Dividends 193
204
215
227
239
252
266
281
296
313
Drip 13.96
14.73
15.54
16.39
17.29
18.24
19.25
20.31
21.42
CDI 619.73
651.99 685.94
721.66
759.23
798.76
840.35
884.11
930.14
Normal Income 617.46
649.56 683.34
718.87
756.26
795.58
836.95
880.47
926.26
AEG 2.27
2.43
2.60
2.78
2.98
3.18
3.40
3.64
3.89
4.16
Change in Residual Income 2.27
2.43
2.60
2.78
2.98
3.18
3.40
3.64
3.89
PV Factor 0.9326
0.8697 0.8111
0.7564
0.7054
0.6578
0.6135
0.5721
0.5335
PV of YBY AEG 2.12
2.11
2.11
2.10
2.10
2.09
2.09
2.08
2.07
Core Income Perpetuity 576 AEG Valuation Model
Total PV of YBY AEG 18.87 Growth Rate
AEG TV Perpetuity 30.69 Ke 0% -10% -20% -30% -40% -50%
57.52
3.32% 279.97
183.48
169.74
164.25
161.29
159.45
Adjusted Income Perpetuity 625 4.62%
145.12
115.70
110.18
107.84
106.56
105.74
Initial MVE 8,649.91 5.93%
89.07
80.14
78.10
77.19
76.68
76.35
divide by shares 151.26 7.23%
60.97
59.23
58.77
58.56
58.43
58.35
Model Price 57.19 8.53%
44.81
45.75
46.03
46.17
46.25
46.30
Time Consistent 60.97 9.84%
34.61
36.49
37.11
37.42
37.61
37.73
11.14% 27.85
29.95
30.70
31.09
31.33
31.48
199
Observed Share Price (5/30/08) 57.13 Undervalued > $66
Cost of Equity 7.23% Fairly Valued 15% of Observed Price
Growth Rate 0.00% Overvalued < $49
Observed Price $57.13
200
Long Run Residual Income Model Long Run Residual Income Model
Actual Restated
Initial BE 171 Initial BE 171
Average ROE -
49.80% Average ROE 6.90%
Ke 7.23% Ke 7.23%
Forward Earnings Growth 11.25% Forward Earnings Growth 10.20%
6/30/2007 Estimated MVE
2,596.90 6/30/2007 Estimated MVE
190.00
Restated AEG Valuation
0 1 2 3 4 5 6 7 8 9 10 Perp.
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Net Income 522
549
578
608
639
673
708
744
783
824
Dividends 193
204
215
227
239
252
266
281
296
313
Drip 13.96
14.73
15.54
16.39
17.29
18.24
19.25
20.31
21.42
CDI 563.19
592.51 623.37
655.83
689.98
725.91
763.72
803.49
845.33
Normal Income 559.83
588.94 619.56
651.78
685.67
721.33
758.84
798.30
839.81
AEG 3.36
3.58
3.81
4.05
4.31
4.59
4.88
5.19
5.52
5.85
Change in Residual Income 3.36
3.58
3.81
4.05
4.31
4.59
4.88
5.19
5.52
PV Factor 0.9326
0.8697 0.8111
0.7564
0.7054
0.6578
0.6135
0.5721
0.5335
PV of YBY AEG 3.13
3.11
3.09
3.06
3.04
3.02
2.99
2.97
2.95
Core Income Perpetuity 522 AEG Valuation Model
Total PV of YBY AEG 27.37 Growth Rate
AEG TV Perpetuity 43.20 Ke 0% -10% -20% -30% -40% -50%
80.98
3.32% 258.39
168.36
155.55
150.42
147.66
145.94
Adjusted Income Perpetuity 593 4.62%
135.23
106.81
101.48
99.22
97.98
97.19
Initial MVE 8,197.14 5.93%
83.74
74.43
72.30
71.36
70.82
70.48
divide by shares 151.26 7.23%
57.77
55.33
54.68
54.38
54.21
54.10
Model Price 54.19 8.53%
42.76
42.98
43.05
43.08
43.09
43.11
Time Consistent 57.77 9.84%
33.24
34.47
34.87
35.08
35.20
35.28
11.14% 26.90
28.44
28.99
29.27
29.44
29.56
Observed Share Price (5/30/08) 57.13 Undervalued > $66
Cost of Equity 7.23% Fairly Valued 15% of Observed Price
Growth Rate 0.00% Overvalued < $49
Observed Price $57.13
201
Number of Shares 151.26 Number of Shares
151.26
Initial Share Price (6/30/07)
17.17
Initial Share Price (6/30/07)
1.26
Time consistent Price (6/01/08)
18.30
Time consistent Price (6/01/08)
1.34
LI RI Model (Actual) LI RI Model (Restated)
Growth Rate Growth Rate
Ke 9% 10% 11% 12% 13% Ke 9% 10% 11% 12% 13%
3.32% 12.06
10.43
9.22
8.29
7.56 3.32%
12.06
10.43
9.22
8.29
7.56
4.62% 15.82
13.10
11.23
9.87
8.83 4.62%
15.82
13.10
11.23
9.87
8.83
5.93% 22.83
17.51
14.29
12.13
10.59 5.93%
22.83
17.51
14.29
12.13
10.59
7.23% 40.04
26.02
19.44
15.62
13.12 7.23%
40.04
26.02
19.44
15.62
13.12
8.53% 152.46
49.57
30.00
21.70
17.12 8.53%
152.46
49.57
30.00
21.70
17.12
9.84% N/A 460.50
64.58
35.25
24.49 9.84% N/A
460.50
64.58
35.25
24.49
11.14% N/A N/A N/A 89.50
42.05 11.14% N/A N/A N/A
89.50
42.05
ROE held constant -49.8% ROE held constant -49.8% Overvalued <
$49 Fairly Valued 15% of
Observed Price Undervalued
> $66 Overvalued <
$49 Fairly Valued 15% of
Observed Price Undervalued
> $66
Observed Price $57.13 Observed Price $57.13
LI RI Model (Actual) LI RI Model (Restated)
ROE ROE
Ke 0% 5% 10% 15% 20% Ke 0% 5% 10% 15% 20%
3.32% 1.65
0.92
0.18 N/A N/A 3.32%
1.65
0.92
0.18 N/A N/A
4.62% 2.00
1.11
0.22 N/A N/A 4.62%
2.00
1.11
0.22 N/A N/A
5.93% 2.52
1.40
0.28 N/A N/A 5.93%
2.52
1.40
0.28 N/A N/A
7.23% 3.37
1.87
0.37 N/A N/A 7.23%
3.37
1.87
0.37 N/A N/A
8.53% 5.04
2.80
0.56 N/A N/A 8.53%
5.04
2.80
0.56 N/A N/A
9.84% 9.83
5.46
1.09 N/A N/A 9.84%
9.83
5.46
1.09 N/A N/A
11.14% 127.38
70.76
14.15 N/A N/A 11.14%
127.38
70.76
14.15 N/A N/A
Growth held constant at 11.25% Growth held constant at 11.25% Overvalued <
$49 Fairly Valued 15% of
Observed Price Undervalued
> $66 Overvalued <
$49 Fairly Valued 15% of
Observed Price Undervalued
> $66
Observed Price $57.13 Observed Price $57.13
LI RI Model (Actual) LI RI Model (Restated)
ROE ROE
202
G 0% 5% 10% 15% 20% G 0% 5% 10% 15% 20%
9.00% 6.13
2.72 N/A N/A N/A 9.00%
6.13
2.72 N/A N/A N/A
10.00% 4.35
2.18 N/A N/A N/A 10.00%
4.35
2.18 N/A N/A N/A
11.00% 3.52
1.92
0.32 N/A N/A 11.00%
3.52
1.92
0.32 N/A N/A
12.00% 3.03
1.77
0.51 N/A N/A 12.00%
3.03
1.77
0.51 N/A N/A
13.00% 2.72
1.67
0.63 N/A N/A 13.00%
2.72
1.67
0.63 N/A N/A
Ke held constant at 7.23% Ke held constant at 7.23% Overvalued <
$49 Fairly Valued 15% of
Observed Price Undervalued
> $66 Overvalued <
$49 Fairly Valued 15% of
Observed Price Undervalued
> $66
Observed Price $57.13 Observed Price $57.13
203
References
1. www.thecloroxcompany.com
2. www.moneycentral.msn.com
3. Colgate-Palmolive 2008 10-K
4. Proctor & Gamble 2008 10-K
5. The Clorox Company 2005 10-K
6. The Clorox Company 2007 10-K
7. The Clorox Company 2008 10-K
8. SFAS No. 142
9. SFAS No. 158
10. Business Analysis Evaluations, Palepu & Healy
11. www.investopedia
12. http://research.stlouisfed.org