Share price and intrinsic value : an investigation into this relationship for food stocks listed on the JSE

Abstract

Internationally investors are looking at emerging economies such as South Africa, India, China and Mexico to earn high returns on investment. Investments in these markets are due to the possible high returns and the low correlation with developed markets. Individual listed company's performance determines the likelihood of shareholders investment. It is claimed that if a company truly creates value it will be reflected by the rise in share price. The intrinsic value of a share (defined as Ṗ○) is the fundamental value of the share as seen by the marginal investor performing the analysis. The intrinsic value of a share shows the nature of the shares potential according to the marginal investor. The intrinsic value of a share is specifically determined by the future cash flows generated by the operating activities of the company in which the shares are held. If the intrinsic share values and the market share price are equal it will mean the stock market is efficient. The corporate valuation model is based on determining the value of company operations by calculating the present value of the expected future free cash flows discounted at the weighted average cost of capital. The research sample consists of the thirteen companies included in the JSE Limited Food Producers Index. The study period is over 16 years which starts in 1992 and ends in 2007. The objective is to determine whether a linear relationship exist between the market share price as well as the change in market share price and the intrinsic share value of the companies listed on the Food Producers Index. The intrinsic share value was determined by using the corporate valuation model. Due to the volatility of the rate of return on the All Share Index three scenarios was set to determine the rate of return. For scenario one the value for the market return rate was that of each year included in the study. For scenario two the market return for the average 40 years (13%) was used as the return rate. For scenario three the market return was set at the. average return of the JSE Limited Food Producer Index over the period of the study (1992 to 2007) which was equal to 18.69%. The three scenarios gave three different values for

the weighted average cost of capital and therefore three different intrinsic share values. In order to test the strength of the relationship between the dependent and independent variable a simple linear regression was performed. The regression analysis was first performed on the change in market share price and the three different intrinsic values. The analysis was also done for each company over all the years and for each year over all the companies. The second linear regression analysis was performed on the market share price and the three different intrinsic values. The analysis was also done for each company over all the years and for each year over all the companies. The F test for the slope of the linear regression equation was conducted at a confidence interval of 95% as test for a significant linear relationship. The change in market share price and the independent variables the three intrinsic share values for the different market return scenarios relationship are not linear for most of the companies and most of the years. The dependent variable, market share price and the independent variables the three intrinsic share values did not show significant linear relationships for the companies. The relationship is linear for the majority of the individual years over all the companies. A possible explanation for the significant relationship is that companies of the food producers' index form a portfolio of shares. A portfolio of shares reduces the risk involved with each individual company. Although the companies are all food producers there sub-industries are significantly different. This means that every company will have different cost drivers that influence profits and cash flow. There is therefore a linear relationship between the share price and the share value over the majority of the individual years over all the companies.