Risk analysis refers to the uncertainty of forecasted future cash flows streams, variance of portfolio or stock returns, statistical analysis to determine the probability of a project's success or failure, and possible future economic states. Risk analysts often work in tandem with forecasting professionals to minimize future negative unforseen effects. Almost all sorts of large businesses require a minimum sort of risk analysis.
Table 5.1 Summary of Risk and Statistical Analysis
RETURN
VARIANCE
STANDARD DEVIATION
COEFFIENT OF VARIATION
KLK BERHAD
0.006654
0.001809
0.042537
6.392416
BATU KAWAN BERHAD
0.006058
0.00124303
0.035257
5.819883
KUALA LUMPUR COMPOSITE INDEX
0.003706
0.00041587
0.020393
5.50338515
Based on the figure above, Kuala Lumpur Kepong Berhad (KLK Berhad) return is much higher as to compare with Kuala Lumpur Composite Index (KLCi) and Batu Kawan Berhad. Variance for the company is also stated higher compare to Batu Kawan Berhad and KLCi. The standard deviation and coefficient of variation for KLK Berhad is also higher by 1.0 in comparision with Batu Kawan Berhad and KLCi.
5.2 Regression Analysis
In analyzing the company's financial; regression analysis is the other element of analysis and import in helping the investors to know whether the company share is underpriced or overpriced. This will help investors to decide whether to invest or not in that particular shares.
5.2.1 Securities Market Line
Securities Market Line (SML) is a line that graphs the systematic, or market, risk versus return of the whole market at a certain time and shows all risky marketable securities. The SML essentially graphs the results from the capital asset pricing model (CAPM) formula. The x-axis represents the risk (beta), and the y-axis represents the expected return. The market risk premium is determined from the slope of the SML. The security market line is a useful tool in determining whether an asset being considered for a portfolio offers a reasonable expected return for risk. Individual securities are plotted on the SML graph. If the security's risk versus expected return is plotted above the SML, it is undervalued because the investor can expect a greater return for the inherent risk. A security plotted below the SML is overvalued because the investor would be accepting less return for the amount of risk assumed.
Figure 5.2.1 Securities Market Line
E(r)
2.8 SML = 2.8% + β (0.37% - 2.8%)
βm = 1 1.2458 β
-0.2273
The Securities Market Line above depicts the expected return for Kuala Lumpur Kepong Berhad. The expected return as can be seen is -0.2273. If the beta is greater than 1, then the risk premium must be greater to compensate the investor for the additional risk; if it is less, then the risk premium will be less. All securities above blue line (SML) are undervalued and all securities below SML are overvalued. The above shows that CAPM return is greater than expected return which the stock is overvalued. Therefore, the best recommendation for the investors is to sell the shares.
5.2.2 Security Characteristics Line
A line formed using regression analysis that summarizes a particular security or portfolio's systematic risk and rate of return. The rate of return is dependent on the standard deviation of the asset's returns and the slope of the characteristic line, which is represented by the asset's beta. A characteristic line of a stock is the same as the security market line, and is very useful when employing the capital asset pricing model, or when using modern portfolio formation techniques. The slope of the line, which is a measure of systematic risk, determines the risk-return tradeoff. According to this metric, the more risk take on as measured by variability in returns the higher the returns you can expect to earn.
Figure 5.2.2 Security Characteristics Line
SECURITIES RETURN
SCL
0.00657 - - - - - - - - - - - - - -- - - - - --
0.00204
Market Return
0.006657
Ri = α+β(Rm)
= 0.00204 + 1.2458 (0.003706)
= 0.006657
The following graph depicts the Security Characteristics Line (SCL) for Kuala Lumpur Kepong Berhad (KLK Berhad). It measures the degree to which a security's returns comove with the returns on the market. Because of the standardization, the beta can be interpreted as the slope of the regression line of the security or asset return on the market return. The return for the market as can be seen on the graph is relatively high. they are positive relationship between stocks and market where every 1% changes in market return will lead to 1.2458 % changes in company return.
5.3 INTRINSIC VALUE
Intrinsic value is represented the value that the buyer could attract from the option if investor exercised it immediately. It is the fair value of the company's common stock.
The conclusion is the intrinsic value of the particular stock plays an important role in the fundamental approach to the common stock investment because it serves as the cut of the price for the investment decision.
Company's intrinsic value is underlying or inherent value of the stock, as to determine through the fundamental analysis. It provides a standard of helping to judge whether the Boustead Holdings Bhd. is overvalued or undervalued.
The calculation for intrinsic value:
Price Earning Ratio = Market Price 2010/EPS
= 22.10/ 0.95
= 23.26x
Growth Rate, g = k - Dps 2010/Price 2009
= 0.6654% - (0.54/ 16.5)
= 0.63%
Expected EPS = ( 1 + g ) - EPS
= ( 1 + 0.63 ) - 0.95
= RM 1.55
Intrinsic Value = Expected EPS - PER
= 1.55 - 23.26
= RM 36.05
Intrinsic Value vs Market Price( Jan 2011)
RM 36.05 vs RM 22.86
The intrinsic value of Kuala Lumpur Kepong Berhad stock is much higher as to compare with the market price at January 2011 which means it is underpriced. The intrinsic value at RM36.05 whereas the market price values at RM22.86. It is advisable to buy the stock since it is much cheaper than the intrinsic value.
