Financial Accounting

In Singapore, OCBC has a great influences in the banking and financial development of the country. It was found out of the Great depression in 1932 with the head understanding that people are having difficulties in financial sector. Nowadays, OCBC is known as the longest established bank in Singapore for constantly providing the financial solution for their client to meet their needs. The bank produces variation of products and services such credit loan, payment installments, insurances, and many others. OCBC bank has some subsidiaries to support each other’s growth and expand the business; they have sub branches in most of the countries in Asia and also Australia.

OCBC is working together with its parent company, Great Eastern Holdings Limited to help the company providing services in insurances sector. Meanwhile, OCBC owns the shares of the insurance company for more than 80%.

The application of micro and macro environment factors in the business also affects company’s performances. However OCBC bank is likely to be affected more with the macro factors instead of the micro level of issues. It is because of the gross domestic product’s growth in Singapore and other sectors such inflation rate and trending issues in current market. Nevertheless, the most important factor is the government policies, rules and regulation that require banks and any other financial institutions to adapt and follow.

Based on OCBC’s efficiency ratio, we can conclude that within the recent two years, OCBC has been stable in generating revenues using their assets and equity. Instead of their closest competitor, OCBC is rather lagging with their efficiency and performances. OCBC still consider with low profits over the year even with an increase in their revenues. In terms of their profit, OCBC has outperformed their competitor but will not generate high return for their investors. OCBC share price has also climbed up within recent months compared to the sudden fall in Q4 2015 and it is predicted to rise up in the future, even with a lower margin.

OCBC has a comprehensive suite of products, measured according to the market’s investment goals and risk profiles. The dedication is in order to grow the investment portfolio by maximizing returns and minimizing risks. OCBC diversified their investment products to meet the market’s demand. They provide services with high risks and high return such Dual Currency Return and Singapore Savings Bond. In the other hand, they provide the investment instrument with lower risk with lower return too such the Blue Chip Investment Plan and OCBC securities. Both are observed by brokers to control the transactions.

OCBC has the highest net profit margin compared to its competitors. Though, they also have a lot numbers of investors. Therefore, there will be less return on equity and it is advisable for the investors who plan to put their major equity not to invest in OCBC. In contrast, OCBC still continues their operation with a robust growth in their financial services.

Part 1

OCBC is abbreviated of Oversea-Chinese Banking Corporation Limited, it is a gathering banks and known as the longest well established bank in Singapore. The bank is generally formed in 1932 and was a converged of three neighborhood banks. OCBC have constantly solid for its administrations and their comprehension about the financial needs to the client. Their services capacity is dependable to make a fulfillment and solution for their loyal customers. Meanwhile, OCBC has some bank subsidiaries such OCBC NISP, OCBC Wing Hang Bank, Bank of Singapore and Bank of Ningbo. The bank is growing and it is listed in the public financial stock at $8.92 per share price.

The development in the financial sector, has named OCBC to be recompensed by Bloomberg in 2011 and 2012 as the World's Strongest Bank. The accomplishments never pull the bank to quit developing and even the groups have a tendency to extend their business differently and spreading over the geographies.

OCBC's vision is to be the main bank choice with a world standard and perceived for its capacity and dependability. OCBC has two parts of value to make a separation with the contenders. The first principle is in quality perspective, they want to ensure that the services they gave has zero defects and incredible constantly. The other one is to ensure the incomparable customers experience; they conduct vision to construct a passionate engagement to their customers. They believe that their visions could create the highest public trust through ethical, caring and prudent performances.

To comprise the social responsibility, OCBC shows supports through an association with Singapore Children Society and mainly donate $5 million for 10 years period since 2004. Another activity is within the presence of OCBC Child Development Account (CDA), this scheme created with purpose to teach them about savings habit. Furthermore, there are some other social project directed by OCBC such Staff Volunteerism, The Straits Times Pocket Money Fund, and Willing Heart Programs. Large portions of the projects are subjected to the education subsequent to OCBC concerns about the education excellence for the young generation.

OCBC’s current ratio has declined over the past 2 years. This implies that the bank’s ability to repay their short-term and long-term obligations has deteriorated. Even though their liability is decreasing, but their current assets have fall further down. However, the low current ratio might be due to the nature of the business, where bank uses the current asset to loan out for a longer period of time.

Asset turnover ratio shows us how efficient a company is in utilizing their assets to generate revenue. The Total Asset Turnover has been stable over the year for OCBC. However, their total sales have actually grown a few millions compared to the previous year, in line with the increase of their total asset. Additionally, Equity turnover ratio measures the proportion of a company's sales to its stockholders' equity. It determines how efficient a company in using equity to generate revenue. The Equity turnover for OCBC has also declined, due to the growth of equity exceeds the growth of net sales of the year. Thus, with a larger number of equity, OCBC can only generate smaller amount of revenue. However, in the early 2015, OCBC has launched several services thanks to the partnership established such as SMRT, Great Eastern and NTUC, which contributed to the increase in the sales.

Net Profit Margin The NPM (net profit/net sales) measures how much profit company makes from its sales.   Based on the calculations we found that the NPM fall in an acceptable amount over the two years. The slight fall is due to the increase in net income is not as high as the growth in net sales. This might be due to the interest rate policy that has caused the bank’s interest rate margin to fall for the year 2015, thus resulting in lower profit generated although the bank has made larger sales.

Operating Profit Margin is operating profit/net sales. The major reason is the drop of operating profit accompanied by the increase in the sales. In addition to the interest rate policy, staff wages and other operating expenses has also increased in 2015. This might cause OCBC to weaken in the competition, as they have to maintain a higher rate in order to protect its profit.

OCBC’s profitability seems to slip in a small amount in 2015 compared to the previous year. Assessing its net profit and operating margin, we can conclude that OCBC is better in managing their overhead, wages and other operating expenses based on its higher net profit margin. In 2014, OCBC’s revenue increased due to the innovation, which entitled OCBC as the first bank to allow deposit account opening through internet.

Current issue faced by the company is as follows:

· The setting up of Financial Technology and Innovation Unit will allow OCBC in gaining competitive advantage, as it will help in bringing solution to OCBC consumer problems, thus upgrading the service they receive as well as helping the management in reducing operational expenses in the future.

· Slower economic growth in the recent year is predicted to continue in the future. Although inflation is cooling down, the growth itself would not be a significant one. Thus, the company should also expect the revenue growth to complement the economy, which will be a slow increase compared to the previous year.

We have included the share price of OCBC for the span of 5 years. During 2013 and 2015, the share price reaches its highest peak at 10.5 to 11, although there were moderate falls in 2014 share price. The lowest share price was in 2012, and 2016. In 2013, the OCBC stocks has bullish outlook, as the Fed prepared to start cutting back asset purchases in response to the growing strength of U.S economy. However, due to OCBC’s huge effort in its plan to take over Hong Kong’s Wing Hang Bank, the shareholders might find the steps to be rather risky that they start withdrawing their stocks, causing the share price to hit six months low in 2014 (Bloomberg,2014). The share price climbs back to its position in 2015 after the acquisition plan has been wrapped up. The drop in share price in the early 2016 was caused by the downturn in gas and oil industry impacting the banking industry as a whole. However, with the correction of oil and gas price, the OCBC share price is expected to grow within the coming months.

The ratios for the year 2015 are as following:

Based on the current ratio, OCBC’s internal liquidity is within the industry standard for the past 2 years. The benchmark of the bank industry basically has lower current ratio compared to the other industries, thus the low ratio given. This implies that OCBC has the similar ability to pay off their liabilities to the depositors, with DBS having the lowest internal liquidity among the compared banks although it has higher amount of current assets.

OCBC’s asset turnover was proved to be lower than its competitor, although not by much. Although UOB has the lowest net sales compared to the other two, it has a lower net asset, thus generates more sales for each asset they possess. With the fact, OCBC is less efficient in utilizing their assets to generate revenue in the business.

UOB has incredibly high Equity Turnover Ratio compared to its peers, with the average of 1.9times sales generated for each equity. However, the low number of shares issued by UOB is one of the major reason for the high ratio, where DBS and OCBC issues approximately 2-3 times more shares to UOB. This prove that within the industry, UOB has exceptional skill in generating the almost comparable sales with much lower equity required.

In terms of Profitability, OCBC was actually doing better than the average banks in the industry. We believe, the interest rate margin where OCBC operated is actually higher than its competitor, hence the production of higher profit for each sales they made, and resulting in higher Net Profit Margin. Moreover, OCBC lead in the Operating profit margin, partly due to the interest margin that they applied. However in terms of wages and overheads, OCBC has the similar expense to the other banks, implying that they have similar ability in managing the operating expenses. Despite the high profitability ratio, OCBC generates lower return to shareholders as they issued large number of shares, although they generate high profitability.

Currently the gross domestic product reported by the Statistic Singapore has been increasing and reaches the amount of 331.00 Billion USD. The forecast has been conducted to oversee the upcoming growth in the second, third and last quarter of 2016. The chart above shows the economic growth rate in Singapore for the past 5 years period. In 2011, the GDP growth has been at its peak compared to the further rates. The unstable rate is related to the volatile of the country’s financial performances. Based on the forecast conducted with an autoregressive integrated moving average (ARIMA), the gross domestic product in Singapore is expected to increase and reach 338.00 Billion USD at the end of the year. However this model is adjusted with the econometric model by taking into an account for analysts’ assessments and future expectations.

Quoted in Forbes and based on The World Wealth Report 2012, Singapore is nominated as the top for its financial performances. The data relies on the GDP performance performed by Singapore. The report even predicts that Singapore will continue to grow and have a great power in 2050.

The strength for the country’s performance shows the abilities and opportunities for OCBC to take part for its success. It is undeniable that the bank will probably affected with the country’s performances. Hence OCBC’s investment programs determine their vision to grow and earn together with the future.

The chart shows the comparison for the inflation rate for Singapore and United States. The inflation rate implicates the change in consumer price index overtime. Singapore has a lower and stable inflation rate showing that Singapore has more purchasing power because of the stable rate. However in USA, as a high inflation rate occurs, it means that the market has less purchasing power and it might affect the country’s growth. With a low inflation rate, the market in Singapore should hold a higher amount of money and they possibly have the ability to do savings and investment. OCBC as financial intermediaries has a good opportunity in the market to offer their product and services to acknowledge the best experience and profits upon savings.

In the first quarter of 2016, Singapore has beaten with the fall down of its stock market. It is directed by the dragged down exempted by Tokyo market together with the sell-off in the bank stocks of Europe and United States to Japan. Its acquisition has affected a drop in the Singapore’s market price. Moreover, the Noble’s commodity stock, Golden Agri-resource, and Property stocks also has lost some percentage and took a beating in the market. The problem is crucial for Singapore and the three local banks, which incurred with some shedding nearby 3%.

OCBC and many other banks are such the intermediaries to provide loans for property investment and many other functions. The fall in the stocks price significantly affects the banks performances and transaction. Moreover, Banks have a high dependency with the stocks since it affects their profit and loss margins.

In 2014, the Monetary Authority of Singapore represented by Minister Lim Hng Kiang issues a new rule for the banks in Singapore. Banks in Singapore are expected to hold buff cash in case of the emergency. This rule is called as liquidity coverage ratio. The plan is to secure the bank for financial lost and the debt in the future. Monetary Authority of Singapore announced the three local banks in Singapore such DBS, OCBC and UOB will have to meet their requirements of having 100% Sing dollar liquidity coverage ratio and 60% liquidity coverage ratio for the other currencies but increasing annually by 10% and to expected reach 100% by 2019. The rule itself is consistent and reliable with the Basel III rules implemented by international banks. Basel III rule is a global voluntary regulatory framework for the bank to improve the banking sector’s ability to absorb shocks arising from financial and economic stress. It also improves risk management and governance. Lastly, it absorbs to strengthen the bank's’ transparency and disclosures.

Under these regulations, OCBC as one of the local bank in Singapore affected with significant changes as they are requested some requirements in order to balance their existences. OCBC Bank admits to be compliant with the Monetary Authority of Singapore’s liquidity framework and they are getting the bank ready to meet the requirements for Basel III.

To examine, the growth rate in Singapore is increasing overtime. This suggests the country’s performances and powers upon their reliance with the other sectors. OCBC Bank as a trusted local bank in Singapore provides the business of cash and credits products to attempt the transaction needs in investment, banking and financial intermediaries with the environment that has a low inflation rate. The property, gas/oil, and commodities in Singapore also affect the banks affair since it is correlating to each other and affecting in mutual industries. OCBC works together with government policy and regulation to compliant with the requirements needed. Liquidity ratio and Basel III rule examines the example, both also implicates the nature of the policies made and how OCBC reacts upon the problems shows the open-minded step for about their existence. As an addition, OCBC has a great investment prospects since they look forward for the future obstacles

In the history of OCBC Bank, OCBC operated since 1932 out of the Great Depression with three consolidated banks. It was a period of the economy crisis and the founders of OCBC understood that people have difficulties in subject of their financial; the founders then took an opportunity to create a financial solution for personal needs and support the community in that era. Over the period till 1950, OCBC has a huge inclination and become the biggest bank in Singapore and Malaysia. Moreover, they become the only bank that has a branch in China stating at Xia Men. The other highlighted growth is in 1970 which OCBC has total resources for more than S$1 billion and acquired to be the biggest deposits bank in Singapore.

For more than 30 decades, OCBC has grown through serving the best services in the financial sector; they merge and blend with the market in Singapore, Malaysia, Indonesia, and Greater China. Furthermore, OCBC also the first financial institution in Singapore who embrace their consolidation with acquiring Keppel Capital Holdings Ltd together with all of its subsidiaries. In 2008, the parent company Great Eastern Holdings which work more in insurance sector, associated with higher stakes with 87.1% from the previous of 48,8%, it is therefore leverage in the strength of both business corporation. The likelihood of the relationship between OCBC and Bank of Singapore also has brought them into a stronger presence for their high net worth and basing their position as a great wealth management player in Asia.

        In 2014, OCBC becomes the first bank in Singapore releasing the application in the mobile devices or tablet to open the bank account. OCBC understood that the market behavior shows the likelihood to go mobile for their daily lifestyle. They seek to make banking system more convenient with innovative products and services. OCBC has targeted their application for PMET (Professionals, Managers, Engineers and Technicians), age ranging from 23-25 years old. The product itself made in order to have the customers simpler banking operation without going to visit the branches. Within six months period, there were 8000 new accounts opened with the application. The new accounts holders also bring 15% more of the total opened account on that period.

        OCBC realizes that the growth in the technology is not only profiting the online shop, payments and etc. Moreover, they believe that their application might also help people to make profits from their interest. They provide solutions through technology with the base understanding of market behavior. The new application will also improve the business appeal for the market to feel more secure, well developed for banking and financial institution.

        Last year, Singapore is celebrating their 50 years as an independent country. CEO of OCBC, Samuel Tsien told his thankful on the growth for being the longest established bank in Singapore and nevertheless, he thanks their colleagues for their dedication and hard work to grow the bank and become better and better each day. OCBC took the event celebration as an opportunity for the company to reward their employees. They reward their employees with the product that they believe will not only useful for individual but it will be something that can be enjoyed with their loved families and friends.

        Firstly, they reward about 3000 of their junior executives and unionized employees with 100 shares of OCBC, this also in purpose to allow them starting their investment journey that believed to be one of the key in great financial planning. The second reward is the exclusive OCBC SG50 Nets Flashpay that spread within 8000 of their employees in Singapore. The card itself will be preloaded with $100 inside the credit. It is also design with red dots symbolizing the unity of OCBC’s employee to celebrate 50 years of the nation building.  Moreover, the employees in Singapore’s branch received four tickets of Garden By The Bay tickets. They can also purchase Universal Studios Singapore with $5 top-up and up to four tickets only. Overseas employees also receive the same compliment provided by the bank in their own countries.

        Furthermore, the staffs also get their privilege with double flex benefits and SG50 mobile application. The flex benefits are useful for obtaining reimbursement for wide ranges of items such medical expenses for family and travelling expenses. While SG50 application is fun and an interactive quiz application with subject related with OCBC’s Bank History. The bank believes that the app will allow them to understand further about the company.

        OCBC bank truly understands that their employees are one key part that help them in development, they show respect with the rewards with an opportunity of sharing their shares, financial reward, recreation and etc. This shows their credible point in their employees to keep up their good work and performances.

In Singapore market, OCBC is standing with two other local banks that also have a great reputation in the market to be trustworthy and reliable. They are UOB and DBS Bank. Both banks are competing with OCBC to provide the best financial solution for the market.

DBS Bank Ltd is a Singaporean multinational banking and financial services company. It was known as The Development Bank of Singapore Limited and changed into the present name in 2003. The role of DBS in Singapore is to be a regional bank in Singapore. At the present day, DBS is leading with the higher interest rate compared to its competitors. DBS is leading overtime because of the consistency in financial fundamentals with robust asset quality, good capital adequacy levels, and healthy funding and liquidity profiles. DBS has some subsidiaries such as POSB Bank, DBS bank (Hong Kong) and The Islamic Bank of Asia. In 2014, DBS bank announces to launch $50 million to strengthen the corporate social responsibility efforts in Singapore and across the Asia.

        Founded in 1935, UOB (United Overseas Bank) is founded as United Chinese Bank (UCB) by Sarawak business man Wee Kheng Chiang. This bank was set together with a group of Chinese businessman. UOB is the third largest bank in South East Asia accounted by its total assets. UOB is a Singaporean multinational banking organization having its head office in Singapore and having branches in almost countries in South Asia. UOB provides the commercial and corporate banking services as well as personal and private banking operations. They also provide financial venture capital, investment and insurance services. UOB has 68 wide branches in Singapore and network of 500+ offices in 19 countries across Asia Pacific, Western Europe and North America.

        OCBC, DBS, and UOB are three local banks in Singapore who work best in providing the financial services in the country. They all provide the banking and financial system to be delivered to the customers. However, all of them have their own singular advantage to be the key competition to be competed. There are a lot of variation in their products and services, they market their services to be the best institution and make profits upon it. As of the time, the banks are growing and continue developing with launching new products and services. The presence of the competitors also affects each other for their marketing, sales, advertising, and many other decisions to be made.

ROE measures the rate of returned on the equity provide by common shareholders and it reflects the firm’s ability to generate return by using the shareholders’ money. The higher the ratio, the better it is for shareholders. In the report, we use 3-step DuPont system to completed ROE. In this stage, we chose DBS and UOB as our competitors and use cross-sectional analysis to compare the ROE among the three companies.

3-step DuPont Comparison with DBS and UOB

The operating profit margin shows how much revenues are left over after a company paid all their operating cost. From the data above, most of the times, OCBC’s operating profit margin was the highest among the others. This means we can say that OCBC is the most stable. OCBC can generate enough money from their operations to support its business.

Total asset turnover can be calculated by net sales divided by total asset. Most of the times, OCBC’s total asset turnover was the worst among the competitors. This means the company performs badly in utilizing its total assets to generate earning. From 2012 to 2013, OCBC’s TAT decreased from 0.027 times to 0.02 times resulting in smaller ROE. From 2013 onwards, OCBC’s TAT climbs back up and resulting in higher ROE.

The financial leverage is total asset divided by common equity. It measures the proportion of the company’s assets that is utilized by debt. The higher the ratio, the higher the financial risk will be.

During 2011 to 2014, OCBS’s financial leverage is the highest among the others. It means that OCBC has highest financial risk between its competitors. From 2014 to 2015, OCBC’s financial leverage was decreased which would decrease the firm’s financial risk and increase the company’s ability to pay its shareholders. On the other hand, DBS was more leveraged than OCBC and UOB is the most leveraged.

ROE measures the rate of return on the equity provides by common shareholders and it reflects the firm’s ability to generate the return by using the shareholders’ money. The higher the ROE, the more efficient a company is. In 2012, OCBC’s ROE was soaring high. This might be because during 2012, OCBC completed many acquisitions in order to broader its business and generate more return, such as the acquisitions of PT TRANSASIA SECURITIES and PacificMas Berhad. Moreover, from 2011 to 2015, OCBC’s ROE is always the highest. We can conclude that OCBC is the most profitable.

The capital asset pricing model (CAPM) helps us to evaluate the relationship between risk and return to price risky securities. The relationship is described as:

E(Ri)=Rf+βi (Rm-Rf)

Where:

Rf = Risk free rate

βi = Beta of the security

Rm = Expected market return (Phillips 2009)

The risk is calculated by the amount of compensation that an investor expects for taking on the risk. The measure of risk is Beta, which measures systematic risk, multiplied by the market risk premium. The market risk premium is computed by subtracting the risk-free rate from the market return. If the expected return does not compensate the risk after a period of time, investor should not capitalize in the investment.

Figure 1: Security Market Line

Beta measures the responsiveness of a stock's price to changes in the overall stock market. It is shown as systematic risk in the X-axis. The higher the beta (beta above 1), a company will have higher expected return compared to a company with lower beta (beta below 1).

In this report, Beta will be estimated via regression analysis against Straits Times Index (STI).

Figure 2: Raw Beta for OCBC plotted against STI

With the reference to Appendix 1.1, we have derived the characteristic line by plotting the price percentage change of OCBC stock against the price percentage change of STI. The stock prices are taken within a period of 5 years (2011-2015) with monthly prices to generate a percentage change in price. Using OCBC’s monthly adjusted closing price against STI’s monthly closing price, we have calculate that the raw beta is 0.7419.

Based on the calculation, the raw beta is 0.7419 means that the stockholder could expect only a 74.19% rise from where the total market would increase. A lower beta may indicate a lower risk stock with less volatility than the overall market. The lower beta stock may not rise as fast as the overall market but most likely will also not fall as fast either.

A monthly interval is believed to be more appropriate for the regression analysis as shorter interval such as daily or weekly interval will bring non-trade bias and defect the measured correlation with the market index.

To account for beta reliability, the adjusted beta is:

Adjusted Beta = (Raw Beta*) + = Theoretical Stock Beta

= Theoretical Market Beta

From the risk free rate, investor expects interest rate from an absolutely risk-free investment over stated period of time. The risk free rate is the safest investment or minimum rate of return as the investor will not take the additional risk except the rate of return is larger than the risk free rate. However, this is only a theoretical statement as it is impossible for a security to have a zero risk.

From the appendix 1.2, the risk free rate of interest to be used in this model from the yield of a 10 year Singapore Government bond is 2.28%.

There are many advantages of using the 10 years government yield as we can monitor directly the risk free rate even though no need further subjective analysis at the value and easy to check from the number of stated sources (auditable). In addition, if the bond is sold in auction, it also shows the investor confidence. The higher the investor’s confidence, the lower the price of government bond, hence the yield will increase. On the other hand, if investors confidence is low, the price of bond will increase because the demand for safe investment.

We measure the market return based on the Straits Time Index (STI) as they have many listed companies which is more accurate compared to using a single company stock.

With the reference to Appendix 1.3, this report will use the expected future annual return. Thus, the market return is determined to be 0.1870 or 18.7%.

Market risk premium represents deviation from expected return on market portfolio and risk free rate. The market risk premium is defined into three categories:

1. The required market risk premium which is known as the rate which individual investor expect that is beyond that of a risk-free rate.

2. The historical market risk premium which corresponds to the historical differential return of the stock market over bonds.

3. The required and expected market risk premium which is the incremental return of a diversified portfolio over the risk free rate required by an investor.

By using the Straits Times Index (STI) as our benchmark, the market risk premium is calculated to be at 0.16442 or 16.442% with reference from Appendix 1.4.

Hence, the formula to get the market risk premium is:

Rm-Rf = 18.7%% - 2.28% = 16.442%

Assumption:

1. Straits times index is called as the market proxy, because the data in this portfolio is only contain stock.

2. The CPF is known because the risk free rate is compared with the 10 year government bond yield. CPF is superannuation and less sensitive with changes because of market risks change.

3. The calculation of risk premium will be accurate as how much the accurate the given financial data.

The required rate of return is the assurance to compensate the investor for the riskiness of the investment. If the expected return of an investment does not meet or exceed the required rate of return, the investor will not invest.

The required rate of return can be calculated by using the CAPM. Thus, the value for the required rate of return with the reference from Appendix 1.5

The Dividend Discount Model is the stock’s value to take the total of the net present value of all future cash flows of that share of a company, and after that it will be discounted to know if the company is undervalued or overvalued.

The discount rate, dividend growth rate and dividend per share are the vital one to calculate dividend discount model. Most companies decided to only display gross dividends in financial statements, thus, it is vulnerable to dividend risks and hard to estimate. DDM model can be used if the company is paying the dividends, and the company should examine their dividend yield, because company pay huge dividend may net low yields.

There are 3 models of Dividend Discount Model is available, but it is important to use the most relevant one to make sure the calculation is accurate.

1. Constant Growth Model: Acceptable for the stable company with high yield company, however it cannot be used if the stock of dividend yield is low and high dividend growth.

2. Two-Stage Dividend Discount Model: it can be very useful to indicate the dividend will increase at a certain rate after than go down to another growth rate for a number of years.

3. Three-Stage Dividend Discount Model: this model can be used if the company’s earnings of growth rate is high, the FCFE is hard to calculate and the steady leverage.

The requirement characteristics for Dividend Discount Model:

1. High Growth Firms. The high growth company must has low or no need to pay dividend, high return on projects, low leverage and high risks.

2. Stable Growth Firms. The stable growth company must pay large dividends, moderate return on projects with small change for market average, high leverage and average risk with beta that approach to 1.

Assumption:

1. The growth rate will be constant from 2020 onwards

2. Required rate of return will always larger than growth rate (ke > g)

3. Beta will be same, thus ke will not be affected

The growth rate of OCBC in year 2015 is valued at 0.0734 or 7.34% (Appendix 2).

Phase 1 (Slow Growth Rate 2016-2017)

In 2015, Oversea-Chinese Banking Corporation Ltd reported a dividend of 0.36 SGD, which represents a 1.49% increase over last year. Based on the research, OCBC forecasted dividend will be increasing from $0.36 to $0.374 for the period of 2016-2017. Hence, the growth rate is forecasted to be 3.88% (Appendix 2.1).

Phase 2 (High Growth Rate 2018-2019)

We forecast that during the period of 2018-2019, OCBC will have a soaring high growth of dividend and expansion during these years. The rationale behind this is that the company will pay out more dividends to boost shareholder’s confidence. This factor will contribute to a significant increase in an expected dividend growth rate of 40%.

Phase 3 (Stable Growth Rate 2020 onwards)

Starting from 2020 onwards, the company will most probably be at its maturity stage, whereby the dividend growth rate is likely to remain stable at the percentage of 10%.

A stock is worth the future cash flows that is generated by the firm, and discounted back by a rate of return. However, there are some limitations where there may be an incorrect estimation of the length of the first stage. A shorter first stage will cause valuation to be undervalue while a longer first stage can lead to overvalue. Moreover, assuming a direct expansion on the second phase may not be a scenario closer to a reality.

Table 2: OCBC Intrinsic Value

We use the Three Stage Dividend Discount Model to calculate the stock price. NPV is the method of discount cash flow use to calculate the intrinsic share price of OCBC. The derived estimated share price of OCBC is $0.123707. The market price of OCBC as recorded in March 2016 is $9.1. Hence, this means that OCBC share price is overvalued. It can also be interpreted that our estimated of growth is lower than what market perceives. To conclude, a valuation by FCFE model will signify a sell decision.

The results of the sensitivity analysis table show the volatility of changes in dividend and changes in growth of OCBC intrinsic value. For every percent of the increase of growth, the intrinsic value of OCBC will also increase. The price of the stock from this model is sensitive to the chosen growth rate Ke and g as shown in sensitivity analysis.

FCFE is defined as the total amount of free cash flow  that the firm has after meeting all its obligations, including debt obligations, capital expenditure to maintain existing assets, and new asset purchases to maintain the growth rate. This is the cash that can be paid to shareholders after paying for all expenses, debt repayments, and reinvestments.

FCFE is calculated using the following formula:

FCFE = Net Income – (Capital Expenditure – Depreciation) * (1-Debt Ratio) – (Change in Non-cash Working Capital) * (1-Debt Ratio).

The non-cash working capital is concerned with items such as inventory, and accounts receivables. We reduce the FCFE by any increase in non-cash working capital, for example, an increase in accounts receivables.

Assumption:

· Net Income is a net profit after tax

· Capital expenditure is the purchased of equipment

· Depreciation is the depreciation of property

· Debt Ratio is the total liabilities divided by total assets

· Working Capital is the current assets subtracted by current liabilities

· Changes in Working Capital is the ending minus the beginning of working capital

Using FCFE formula to calculate the FCFE per share, the table shows that the history of OCBC’s FCFE value is gradually increasing during 2012-2014. The FCFE value reach its peak at the year of 2014. However, on 2015, the FCFE value decrease rapidly.

Because the FCFE decrease rapidly in 2015, the growth rate of FCFE dropped to the value of -54.83%. It shows that there is a negative growth rate during that period.

The working on the calculation is shown below at the Appendix 3.1

As OCBC has not been experiencing the constant growth rate, to calculate the intrinsic value of share price, we use the multi stage growth model. The intrinsic value is calculated by adding all the present value of the individual years of every period, and followed by the present value of terminal value.

Current phase :

From the year of 2012-2014, the amount of FCFE per share is increasing.

However, in 2015, there is a sudden decline in the FCFE per share. A sudden decline in FCFE indicates that there are economic downturn and slowdown during that period. Moreover, the economy seems to be not performing too well during that time. The FCFE growth rate is -54.83%

Phase 1 (2016-2017) : Slow-Moderate Growth Stage

The consensus seems to be that current phase economic condition will still continue, but with the increase of GDP on January 2016, it is expected that the economy will recover. Based on the forecast from tradingeconomics.com, the GDP growth rate of Singapore will keep increasing until the fourth quarter of 2016. We assume that the FCFE growth rate will increase along with the increase of GDP. Forecasted FCFE growth rate is -30%

Phase 2 (2018-2019) : High Growth Stage

In this phase, global economic recovery, operations, and the increase demand for people to save and invest more, will impact the amount of FCFE during this phase. We assume that during this period, the growth rate of FCFE is 20%.

Phase 3 (2020 onwards) : Stable Growth Stage

It is likely that the growth rate of OCBC will enter a stable growth of 8% in the long term. The proof is that the growth rate in Singapore is increasing overtime. This suggests the country’s performances and powers upon their reliance with the other sectors. OCBC Bank as a trusted local bank in Singapore provides the business of cash and credits products to attempt the transaction needs in investment, banking and financial intermediaries with the environment that has a low inflation rate.

The NPV is 8.05

NPV is the method of discount cash flow use to calculate the intrinsic share price of OCBC. The derived estimated share price of OCBC is $8.05. The current share price of OCBC as recorded in March 2016 is $9.1. Hence, this means that OCBC share price is overvalued. To conclude, a valuation by FCFE model will signify a sell decision.

This analysis tests the values of FCFE to growth. The table shows that if the growth rate decreased, the FCFE value will also decreasing. In contrast, as the growth rate increase, FCFE will also increase. Hence, it is proofed that there is a direct relationship between FCFE and growth rate.

The P/E ratio values the company’s current shares price per share by measuring the price investors are willing to pay for each dollar of earnings made by the company. It enables investors to compare and contrast the intrinsic value of stock of several companies in the same industry with same risk.

A high P/E ratio means that the company is under a high growth and there is future earning potential for the company and vice versa.

There are 3 methods that can be used to calculate P/E ratio.

1.  P/E Ratio =

2.   Price/ Earnings Ratio =

3.  

· The expected growth rate of dividends (g)

· The required rate of return on the stock (k)

· The expected dividend payout ratio (dividends divided by earnings)

PE ratio = Current Market Price Expected 12 - Month Earnings

= 8.91/0.91 = 9.79

The P/E ratio is at 9.79 in the year of 2015.

(Tradingeconomics 2016)

The P/E ratio indicates that investors would be willing to pay $9.358 for every $1 the company generates in the futures. The above ratio shows the P/E ratio of OCBC since 2013. Drawing upon the observation, OCBC’s P/E ratio is lower than 10 except for 2014. This may be due to OCBC’s performance was suffered from lack of demand or lost customers’ confidence in the company. The calculated P/E ratio of 9.79 is relatively close to the 3-year average of 9.358.

(Reuters 2015)

Based on the Table above, the comparison show that OCBC’s P/E ratio has been below the industry and sector’s average as well as the competitors. Beta shows the systematic risk of an asset. OCBC has the lowest beta compared to the competitors, hence, OCBC has lower risk. Investors who invest in lower risk will accept lower return during a weak economic period. The industry’s P/E average ratio might not be an accurate benchmark for fair comparison.

To evaluate OCBC value, we need to compare OCBC with sector, industry as well as their competitors to help better understanding in selecting appropriate portfolios. Considering the similarities in risk and business cycle in banking industry, we decided to compare the P/E ratio with UOB and DBS.

The table above shows the forecasted P/E ratio for the next 5 years.

Price of share in 2016:

=Price earnings (P/E) x Earning per share

=4.32 x 1.02

=$4.4064

From the above calculation, we found that the share price of OCBC needs to make a selling decision because it is overvalued at $4.4064 in 2016, since the market price of OCBC is $9.10 in 21 March 2015.

The table illustrates the sensitivity of OCBC’s share price in relation to its inputs, which are the estimated P/E and estimated growth.

The price/book value ratio is calculated by taking its existing stock price and divide it by its book value.

Formula:

Method 1: P/B ratio = Current Market Price / Book value per share

Method 2: P/B ratio = P/E x ROE

Method 3: P/BVj + =

The ratio is indicative of whether or not a stock of the company is trading at its book value, representing how much a company is worth if it was to be bankrupt or be sold.

A high P/B ratio may indicate the company is overvalued, in terms of its share price, high consumer confidence, or even overestimating the intangible assets and vice versa. (Investinganswers 2015). The PB ratio is only effective in comparison within the industry the company belongs to because of similar capital requirements (Reilly & Brown 2012).

From the above calculation in 2011 until 2015, the P/B ratio of OCBC is decreasing. The decrease of P/B ratio could be because of the poor consumer confidence and the underestimation of the intangible asset. Fall of P/B ratio is also affected by the decreasing of net profit. By forecasting the P/B ratio in 2015, we expected the stock is undervalued because the P/B ratio is lower than 1.

In DuPont analysis, ROE are the largest indication to compare between companies. If the ROE is increasing, it will increase the P/B ratio. By comparing P/B ratio, OCBC and UOB almost have similar ratio, their P/B ratio is lower than 1. DBS is the higher P/B ratio, it is because they have large asset and lesser liabilities that makes their book value to be bigger. In addition, if the share price is higher, the P/B ratio of the firm will be bigger.  

The table above shows the forecasted P/B ratio for the next 5 years.

Price of Share in 2016:

=P/B x Book Value per Share

= 4.32 x 0.92

=$3.97

It shows that the share price is overvalued at $3.97 and OCBC needs to make selling decision. But we need to make assumption that we use a two stage growth model and it is abnormal growth if we use stage 1,  because the stage 1 can be used for technology companies in our given time span, but it is impossible for company like OCBC. The Intrinsic Share Price would yield more realistic market value by assuming a regular growth rate. Hence this can make overvalued for OCBC’ share price (sell decision).

The table shows the sensitivity analysis of share price of the OCBC with small changes bolster confidence of model. If the book value per share is decreasing, the price book ratio will also decrease and vice versa. In that case, it shows there is a direct relationship between P/B ratio and book value per share.

Part 3

The intrinsic value of the company may differ from the current share price.

Intrinsic value is a measure of the actual true value of a company. It also measures the strength and weaknesses of the company. It is measured using fundamental analysis of quantitative factors such capital, shares and profit. In addition, it also includes qualitative factors, likes management quality and intellectual assets. The company share price is used to calculate the company’s market value. Thus, market value can be significantly lower or higher than the intrinsic value. The market value rarely reflects the actual value of a company. It is because the market value reflects demand and supply in the investing market. It shows how willing investors are to participate in the company’s future. If there is a strong investment demand, the market value is usually higher than the intrinsic value (company overvalued). On the opposite, if there is a weak investment demand, the market value will be higher than the intrinsic value and company will be undervalued. It is affected by several factors that is outside the control of the company.

First, market price will be likely affected by market sentiment. In bull market, investors are optimistic so that the market price is likely to increase. On the other hand, the investors in the bear market are pessimistic, thus the market price will fall.  Second, the macroeconomic factors such as interest rate, inflation rate and economic outlook will cause the market to move up and down.

The difference in value across different valuation model is due to the various focus each model apply. For instance, DDM and FCFE method discount the expected future cash flow to determine the company’s value, and is a future-oriented approach. In the DDM approach, net present value of the cash flows determine the company’s true value and if it is lower than the share price in the market, it will be undervalued, and vice versa. However, this method is not capable of calculating the value of a company that doesn’t pay dividend to its shareholders. While in FCFE method, the capital expenditure and the money required for expansion is deducted from the future cash flow available to shareholders.

On the other hand, P/E and P/B ratio actually consider the investors’ perspective of the company, such as how much trust the investors put on the company. P/E ratio based its calculation on the company’s current market price and expected earning. The higher the P/E ratio, the greater confidence that investors put on the company.

The P/B ratio shows the investors concern about the comparison between share price and book value per share. P/B ratio is calculated in light of accounting data under an accrual basis and might probably inaccurate at some points in balance sheet. These reasons show that the ratio is not recommended for the valuation of the shares. As an addition, P/B ratio has no capability for calculating the value of intangible assets.

Dividend Discounted Model

This model will only work if the company pays dividends, and because OCBC pay dividends to its shareholder, DDM model works on OCBC. The derived estimated share price of OCBC is $0.123707. The market price of OCBC as recorded in March 2016 is $9.1. Hence, this means that OCBC share price is overvalued.

However, when this model is used in longer-term analysis, the model does not take into account the possibility of company dividend policy.

DDM model is appropriate because normally bank FCFE is difficult to estimate.

FCFE Model

FCFE model does not seem really appropriate for bank as the periodic variation make it difficult to project average FCFE for perpetuity. That factor may cause the inappropriate share price estimation. The reason is because OCBC is responsive to economic trends. This inconstant movement makes the growth rate and FCFE into perpetuity and makes the share price not really accurate.

PE Ratio

P/E ratio of OCBC is consider low, as it affected by inflation in Singapore. Singapore has face many times of inflation and it causes depreciation costs and inventory are understated, as it needs to do replacement costs, hence P/E ratio is low during high inflation. This model is considered suitable for valuation of OCBC share price as it is based on price and market capitalization, which means we ignore the cost of Debt.

We found that the share price of OCBC needs to make a buying decision because it is overvalued at $2.34 in 2016, since the market price of OCBC is $9.10 in 21 March 2015.

PB Ratio

This model is not suitable for valuation of the share because it is calculated based on the accounting data, where it is based on accrual basis and it might not accurately calculate some items in balance sheet, such as intangible assets.

To conclude, DDM model and P/E Ratio model is seemed to be the most appropriate method to value the current intrinsic share price of OCBC.  

In light of our evaluation, it is advisable for investors to sell of the shares of OCBC. It is due to the information obtained showing the bank’s performance that is not highly attractive. Based on their financial performances, the company has high profits but generate less return for the shareholders. Meanwhile, majority of the valuation models prove that the company is overvalued and their return is less than the market’s expectation. Therefore, we suggest the option to sell OCBC shares for the time being as it will meet the investor's interest In the other side, the competitors such UOB and DBS in Singapore local banks have themselves higher return on equity that bring along larger profits for the investors. As an addition, the share price of OCBC is predicted to fall in 2016 and 2017, hence it is a wise decision to sell the share and buy it back in the future as the rate is expected to grow higher in 2018. Nevertheless, this is to prevent the capital loss during the upcoming year to the investors

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Q 1.1 Financial performance

Current Ratio 2015 = = = 0.2268

Current Ratio 2014 = = = 0.2588

Total Asset Turnover 2015 = = = 0.0208

Total Asset Turnover 2014 = = = 0.0216

Equity Turnover 2015 = = =0.6059

Equity Turnover 2014 = = = 0.7639

Net Profit Margin 2015 = = = 0.4740

Net Profit Margin 2014 = = = 0.4813

Operating Profit Margin 2015 = = = 0.5550

Operating Profit Margin 2014 = = = 0.5920

UOB Current Ratio 2015 = = = 0.2354

Current Ratio 2014 = = = 0.2724

Total Asset Turnover 2015 = = = 0.0237

Total Asset Turnover 2014 = = = 0.0231

Equity Turnover 2015 = = =1.9289

Equity Turnover 2014 = = =1.8508

Net Profit Margin 2015 = = = 0.4352

Net Profit Margin 2014 = = = 0.4763

Operating Profit Margin 2015 = = = 0.5125

Operating Profit Margin 2014 = = = 0.5388

Return on Asset 2015 = = = 0.0101

Return on Asset 2014 = = = 0.0106

Return on Equity 2015 = = = 0.8668

Return on Equity 2014 = = = 0.8239

DBS

Current Ratio 2015 = = = 0.2189

Current Ratio 2014 = = = 0.2829

Total Asset Turnover 2015 = = = 0.0227

Total Asset Turnover 2014 = = = 0.0217

Equity Turnover 2015 = = = 0.8310

Equity Turnover 2014 = = = 0.6492

Net Profit Margin 2015 = = = 0.4375

Net Profit Margin 2014 = = = 0.4410

Operating Profit Margin 2015 = = = 0.5187

Operating Profit Margin 2014 = = = 0.5280

Return on Asset 2015 = = = 0.0097

Return on Asset 2014 = = = 0.0092

Return on Equity 2015 = = = 0.4403

Return on Equity 2014 = = = 0.2813

1.4 3-step DuPont system (OCBC Bank)

ROE =

= Profit margin X Total asset turnover X Financial leverage

2011:

ROE = (2,312/5,661) X (5,661/277,758) X (277,758/20,675)

=11.2%

2012:

ROE = (3,993/7,961) X (7,961/295,943) X (295,943/22,909)

=17.4%

2013:

ROE = (2,768/6,621) X (6,621/338,448) X (338,448/23,720)

=11.7%

2014:

ROE = (3,842/8,340) X (8,340/401,226) X (401,226/29,701)

=12.9%

2015:

ROE = (3,903/8,722) X (8,722/390,190) X (390,190/33,053)

=11.8%

· 3-step DuPont system (DBS Bank)

ROE=

2011

ROE =

= 10.63%

2012

ROE =

= 12.07%

2013

ROE =

= 10.78%

2014

ROE =

= 11.01%

2015

ROE =

= 11.28%

· 3-step DuPont system (UOB Bank)

ROE=

2011

ROE =

= 10.43%

2012

ROE =

= 11.18%

2013

ROE =

= 11.40%

2014

ROE

= 10.99%

2015

ROE =

= 10.43%

Appendix 1.1: Calculation of Beta

OCBC and STI Share Price Data

Beta Calculation using Microsoft Excel Spreadsheet

Adjusted Beta Formula:

Adjusted Beta = (Raw Beta* ) +

= ( 0.7419*) +

= 0.8270

Appendix 1.2: Risk-free Rate

Government bond yield as of February 2016

Appendix 1.3 Market Return

Market Return of Singapore as of March 2016

Appendix 1.4: Market Risk Premium

Risk premium = Rm - Rf

= 18.7% - 2.28%

= 16.442%

The expected market return should be above inflation rate, therefore Singapore GDP needs to be considered to calculate the expected market return. The GDP is forecasted to be upward trend in 2016 with forecasted inflation to be at 2.8 at year 2020 (Trading Economics 2016).

Appendix 1.5: Calculation of required rate of return using CAPM

CAPM = RF + (Rm-Rf)

= 0.0228 + ( 0.187- 0.0228) x 0.7419

 = 0.1446 or 14.46%

Appendix 2: Calculation of growth rate

Retention Rate =(EPS- Dividend per share) /EPS

= (0.952 - 0.36) / 0.952

= 0.6218 or 62.18%

Growth rate = Retention rate x ROE

       = 0.6218 x 0.1181

       = 0.0734 or 7.34%

Appendix 2.1: Calculation of forcasted growth rate

D1        = D0 (1+g)

0.374    = 0.36 x (1 + g )

G          = 3.88%

Appendix 3.1 : History of FCFE value