The talk of will they or won’t they raise rates has been ongoing for more than 2 years now. We have to expect either rates get raised at some point, we stumble along on the current path or we end up in deflationary times. I want to explore the more optimistic of these scenarios and its impact on stock valuations: the economy improves and rates start to rise.
To look at this in detail I am using www.stockcalc.com (Disclaimer: I am the President of Patchell Brook Equity Analytics and we created Stockcalc.com precisely for this type of analysis and valuation)
I will examine Caterpillar as it has with a 59/41 Equity to Debt in the Capital Structure
Using Stockcalc I first create and save a WACC for CAT: (Research Menu, Valuation, WACC). Stockcalc does a first pass on WACC using default values which results in a WACC of 8.93.
Cost of Equity (Ke) 13.63 (Using CAPM), After Tax cost of Debt : 2.17, 59% Equity, 41% Debt
Next I load the Quick DCF tool so I can run the analysis (Research, Forecast, Analyst) (Note – the quick DCF is a testing and teaching tool, the other tools are more detailed in their analysis)
It is available for free at www.stockcalc.com/dcf.aspx or inside the Stockcalc.Com website
Value Per Share ($) Calculations for Caterpillar (CAT:NYS) using the Quick DCF tool on Stockcalc.com
Each change in WACC (8.93 – 9.34 – 9.75) implies a 1 % change in Cost of Debt. Growth rates are next 3 years and thereafter (5% and 3% in the first row for ex)
|Growth rates 5,3%||70.02||61.28||53.60|
|Growth rates 6,4%||97.40||84.92||74.21|
|Growth rates 4,2%||50.55||44.08||38.30|
(Current Price at the time of valuation (October 2015) was $69.34)
A 1% change in the Cost of Debt results in a 12.5% change in value per share. A 1% change in Growth rates results in a 28% change in Value per Share. A 1% change in WACC results in a similar 28% change in Value per Share.
Message: if interest rates are rising, growth prospects need to be rising at half the rate to keep this share price holding steady.
If you want to explore the Stockcalc software simply create an account at www.stockcalc.com and have a look around. Use the walk-throughs (click the walking man icon), videos (video icon on each page) and help menu to understand and navigate the site. The site contains a number of tools including screens, queries, backtests, forecasts and a variety of valuation methods.