2 Simona Brown University of Arizona Global Campus Bus401 Principles of Finance

2
Simona Brown
University of Arizona Global Campus
Bus401 Principles of Finance
Professor Richard Burke
September 13, 2021
Section 3: Dividend Analysis and Preliminary Valuation [WLOs: 1, 4] [CLOs: 1, 2, 4]
United Parcel Service (UPS) is among the leaders in the courier business in the United States. According to Yahoo Finance (2021), the company has a market capitalization of $168.08 billion, and a stock price is about $192.97. Competitors of UPS include the United States Postal Service (USPS) and FedEx. UPS’s profits in 2021 were $3.3 billion, which is 47.3% higher than the profits in 2020. Its stock price rose to $192.97 from $156.97 in 2020, which is an increase of 23% (Yahoo Finance, 2021). The rise in share price indicates that the investors are confident of the organization despite the changes in market conditions due to COVID-19. According to Verdickt et al. (2019), the amount that shareholders are willing and able to pay to be part of a company’s shareholder is referred to as the share price. The share price is determined by the company’s demand at the stock exchange. Nonetheless, to confirm UPS’s true value of shares, it is important to conduct an analysis using constant dividend growth rate to determine whether the market undervalued or overvalued the share price.
Part 1: Dividend Analysis
Table 1: United Parcel Service Annual Dividend
Financial Year
Dividends per share
Annual Growth Rate
10-Year Average
5-Year Average
3-Year Average
2021
4.08
1%
2020
4.04
5.2%
2019
3.84
5.5%
2018
3.64
9.6%
2017
3.32
6.4%
2016
3.12
6.8%
2015
2.92
9%
2014
2.68
8.1%
2013
2.48
8.8%
2012
2.28
9.6%
2011
2.08
7%
5.54%
3.9%
Table 1 summarizes annual dividends at UPS over the past ten years from 2011 to 2021. UPS’s three-year mean dividend growth rate is 3.9%. For the last five years, the average dividend growth rate has been 5.54%, while the 10-year average is 7%. The company recorded a steady increase in share price by $0.02 annually from 2011 to 2014. However, the stock price increased variedly by $0.01 from 2014 to 2021. The annual dividend growth rate also recorded a varied increase throughout the period. Despite the slight variations over the past seven years, it can be noticed that UPA maintained an annual increase in its dividends. The average annual dividend growth analysis is essential in computing the company’s share price since the growth in share price indicates an increase in shareholder’s returns.
Based on the dividend analysis compiled in table 1, we can adopt two different approximations of the company’s future growth rate for its dividend. First, a high-end dividend growth rate reflects an optimistic market. The economy in such a scenario is expected to rise as the company experience an increase in its revenue. Therefore, the company can adopt a high-end dividend growth rate of 7% over ten years. Second, on the contrary, a low-end dividend reflects an economy that experiences recession, leading to moments of uncertainty in the market. Under such circumstances, UPS has a threat of experiencing a reduction in its annual revenue. Therefore, based on the analysis in table 1, the company can adopt a low-end three-year average dividend growth rate of 3.9%.
Part 2: Preliminary Valuation
This section uses the constant dividend growth model to determine UPS’s current stock price using preliminary valuation. According to Verdickt et al. (2019), the model assumes that the organization will offer its investors until infinity. Therefore, the constant dividend growth model assumes the anticipated dividend payments as the forthcoming cash flow shareholders expect for investing in the business shares. As a result, the model applies the formula for discounting cash flow to discount the dividend to infinity (Verdickt et al., 2019). The constant growth formula utilizes a discount rate (r), dividend growth rate (g), and most recent dividend (D) to compute the company’s stock price. The formula for the stock price is as given below:
According to Yahoo Finance (2021), UPS’s market capitalization is equivalent to $168.08 billion, making it among the Standard and Poor’s 500 in the stock exchange market. Therefore, UPS will have the required rate of return equivalent to 10%. When calculating the company’s stock price in the low-end dividend growth rate, we will use the assumed low-end rate of 3.9%. Therefore, the value of (g) will be 3.9%. The rate of return, (r), will be 10%, while the last paid dividend (D) will be 4.08, according to table 1. Therefore,
When calculating UPS’s stock price under the high-end growth rate, we will adopt high-end dividend growth rate conditions assumed in the previous section. As such, the value of the growth rate (g) will be 7%. Similar to the conditions adopted for the low-end dividend growth rate, the value of the rate of return, (r), will be 10%. We will maintain the value of the last paid dividend at 4.08 as per table 1. Therefore,
As of 17th September 2021, UPS’s actual market stock price was $192.97 (Yahoo Finance, 2021). Therefore, the stock price analysis and calculations for both the high-end and low-end dividend growth rates revealed a lower value than the real stock price as specified in stock exchange market. The high-end and low-end dividend growth rates were $145.52 and $69.49, respectively. Therefore, the analysis reveals chances of overvaluing the UPS stock price in the stock exchange market.
Based on the calculation results from the constant growth model, UPS’s concluded stock value is $145.52 per share. The conclusion assumed a dividend growth rate of 7% since the company recorded an increase in its revenue and has a strong interest coverage ratio. Besides, the ratio analysis of UPS reveals a steady increase in return on investment and return on assets, signifying an increase in its profit margin. In addition, UPS has a liquidity ratio of 1.39, which is within the industry range since the average liquidity ratio in the retail industry is 1.76 (Yahoo Finance, 2021). Thus, despite the economic slump caused by the COVID-19 pandemic, UPS managed to maintain its profitability and liquidity. The company also experienced an increase in the competition since most businesses entered the courier and delivery industry due to lockdown caused by COVID-19. However, the increase in the company’s share price indicates that it managed to maximize the shareholder value during the period despite the challenges. Therefore, this information from the company analysis and calculation confirms that the high-end dividend growth rate best reflects the company.
Conclusion
The 10-year dividend growth rate analysis in this paper helps to measure UPS’s long-term profitability. The company’s dividend growth rate revealed the annual average increase in the dividends it paid to its investors. The company had an average 10-year dividend growth rate of 7%. Besides, its five-year average growth rate is 5.54%. Adopting a high-end dividend growth rate of 7% means that the company is optimistic about market conditions and the economy’s stability. Despite the challenges UPS faced last year due to the Covid-19 outbreak and the increase in competition, the company managed to maintain its profitability. Therefore, the company’s concluded stock value will assume a high-end dividend growth rate of 7%.
References
Verdickt, G., et al. (2019). Dividend growth and return predictability: A long-run re-examination of conventional wisdom. Journal of Empirical Finance, 52, 112-127. https://doi.org/10.1016/j.jempfin.2019.03.002
Yahoo Finance. (2021). United Parcel Service, Inc. (UPS). https://finance.yahoo.com/quote/UPS/