Exxon Mobil Corporation (XOM) is a leading company in the Energy business. It deals with a wide range of specialty products including the exploration and production of natural gas and crude oil. It also manufactures petroleum and petrochemicals products globally. It is an American multinational corporation, with its headquarters in Texas. The company’s shares are valued at $56.77 today. Comparing the XOM’s shares performance over the last 3 months, it can be observed that the shares were quoted highest in June 2021 at $63.70 and lowest in July 2021 at $54.52 (Finance.yahoo.com, 2021). The company’s share has been on a downward trend over the last three months. When this share is compared with the overall market index (NASDAQ), it can be noted that the XOM shares are declining given the volatility of the oil and gas market amid the Covid-19 pandemic.
XOM company news over the last few months has been discouraging. For example, Yahoo Finance report dated 7th August 2021 and titled “Dividend Investors: Don’t Be Too Quick To Buy Exxon Mobil Corporation (NYSE: XOM) For Its Upcoming Dividend” (Finance.yahoo.com 2021). Despite having made losses after tax last year, the company is paying dividends of $0.87 per share. It means that despite being unprofitable, Exxon Mobil Corporation is still paying dividends. Although it might be a one-off event, this cannot be sustainable in the long run. For example, if the company’s cash earnings are not sufficient to funds the payment of dividends, it would have to use the cash in the bank or borrow, neither of which is sustainable in the long run. Companies need more cash to cover daily operations, so paying dividends out of cash flow is not recommended, so it is not a prudent financial decision.
The P/E ratio indicates or measures the share price relative to the company’s net annual income per share. Investors use this ratio to determine the demand of a company’s share in the market. A higher P/E ratio is an indication of high demand since investors expect the earnings to grow exponentially in the future. The P/E ratio includes the units of years or simply the number of years of earnings requires to pay back the purchase price. The term ‘’multiple” is used when describing P/E to demonstrate how much the investors are ready to pay per one dollar of the company’s earnings. P/E ratio is sometimes calculated using future earnings expectations, but it is often indicated when this happens.
Exxon Mobil Corporation has a current P/E of 58.50 compared to 2020 P/E of 52.85. The company is projecting to have an average forward P/E of 25.35 over the next five years (Morningstar.com, 2021). It can be observed that Exxon Mobil’s P/E has been in the range of 10.21 and 58.50 over the last ten years. The lowest P/E was 10.21 in 2012 while the highest is the current P/E of 58.50 in 2021. In addition to this, the current P/E (58.50) is way above the 5-year average of 25.35. Over the last ten years, XOM shares have gone down tremendously, so the investors find the prices highly attractive. For this reason, the P/E ratio deviates from the 5-year average. Therefore, the high demand for XOM shares is the main cause of the deviation from the historical trends. Given the high demand for XOM shares, the shareholders believe that there is a huge potential for the shares to go up. However, the current P/E clearly indicates that XOM shares are over-valued since the huge rise in the P/E ratio is slightly over two multiples.
As indicated above, the high demand for XOM shares continues to drive the shares of Exxon Mobil Corporation high. The oil and gas industry has an average P/E of 16.98 and comprises players such as Chevron Energy Corporation, BP PLC, and Valero Energy among other competitors. Comparing XOM’s current P/E with its competitors, Exxon Mobil Corporation has a higher P/E. There are several reasons why XOM commands a premium valuation in terms of P/E. For example, Exxon Mobil is well positioned in terms of capital structure than its competitors. Further to this, Exxon Mobil Corporation has the lowest debt to equity ratio in the energy sector which currently stands at 0.2759. Investors also tend to have more faith in Exxon Mobil than other companies in the industry due to its ability to convert retained earnings into sales when the industry experiences an economic downturn. Even when the prices of oil and gas rises, the company is able to restore its reserves to the desired level from the high profits it generates. Last but not least, Exxon Mobil is more profitable than most of its peers, which explains why it has a higher P/E ratio compared to a significant number of its competitors.
The discounted dividends growth model is simply a technique for valuing the company’s stock price. The model is based on the assumption that the value of a stock is the sum of its future dividend discounted to the present value. A simplified equation commonly known as the Gordon Growth model is used to find the intrinsic value of a stock. One of the advantages of this model is consistency since dividends seem to remain consistent for a long period of time. In addition, this method is more effective since most companies tend to experience significant volatility in measures such as earnings and free cash flows. It is the most ideal method of determining the intrinsic value of a stock for companies like Exxon Mobil Corp that have a stable growth rate in terms of dividends per share. It is also a realistic model since it takes into consideration the net present value of the expected dividends in the future. Unlike other methods like CAPM, it is straightforward and easy to understand.
According to Gordon growth model, the share price=D (1)/(r-g), where D (1) is the expected annual dividend 1 year from now, r is the required rate of return for the common stock, while g is the constant growth rate for the stock. In our case, we assume that Exxon Mobil Corporation’s dividend is expected to grow at a rate of 5%. It is further assumed that the rate of return on equity for XOM stock is 9%.
According to Morningstar.com (2021), Exxon Mobil Corp current dividend is $3.48, so the expected annual dividend one year from now can be estimated as D (1) = $3.48(1+0.05) =$3.654
Now, having estimated the expected annual dividend 1 year from now as $3.654, we can go ahead and calculate the intrinsic value of XOM stock.
XOM stock price= $3.654/ (0.09-0.05)
XOM stock price= $3.654/0.04=$91.35
Thus, from the discounted dividend growth model, the intrinsic value of Exxon Mobil Corporation’s stock is $91.35
References
Finance.yahoo.com. (2021, August 7). Dividend Investors: Don’t Be Too Quick To Buy Exxon Mobil Corporation (NYSE:XOM) For Its Upcoming Dividend. Retrieved from https://finance.yahoo.com/news/dividend-investors-dont-too-quick-083456978.html
Moringstar.com. (2021, August 13). Exxon Mobil Corp XOM dividends. Retrieved from https://www.morningstar.com/stocks/xnys/xom/dividends
Morningstar.com. (2021, August 13). Exxon Mobil Corp P/E ratio valuation. Retrieved from https://www.morningstar.com/stocks/xnys/xom/valuation
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