Valuing Exxon

The final component, the speculative value, equals everything else. The speculative value is calculated by starting with the stock price and subtracting the book value and the value of predictable earnings.

On October 10, when we developed the Exxon model, the market price of Exxon’s stock was $34.90. Rather than detail all the assumptions that are contained in the spreadsheet, I jump to the conclusion of the DCF valuation – a value for Exxon of $39.11 per share. It is worth noting that the estimated value is based on the assumption that the company is in long-term decline.

However, the assumed decline incorporated in the model is apparently less than that assumed by the market because the estimated value exceeds the market price. In addition, the first two components of the value breakdown account for the entire value of Exxon, as there is no speculative value. As a comparison, Zoom and Exxon have almost equal market capitalization, but whereas Exxon has no speculative value, almost the entire value of Zoom is speculative.

Based on the estimate of fundamental value, it appears that Exxon is a buy despite its dim prospects. However, a word of caution: as famed financial economist Fischer Black was fond of noting, DCF models are sensitive to the assumption employed. For instance, with apparently minor alterations of our assumptions, the estimated value of Exxon can drop to $22 or rise to more than $60. It is no wonder why Benjamin Graham demanded a margin of safety between price and estimated fundamental value before he made an investment.

Given the sensitivity of the estimated value to variation in the assumptions, it is tempting to conclude that DCF models are of little use in making investment decisions, but that conclusion is wrong. The simple fact is that is investing is difficult. It requires understanding a business well enough to determine the best inputs into a DCF model. Shortcuts simply hide the complexity and increase the probability of error.

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An electronic version (excel spreadsheet) of the model can be downloaded here. The detailed numbers ...

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