Fundamental Value in Stock Prices: value drivers in the telecommunication sector

Abstract: The valuation of assets and the value of investments has been a frequently discussed phenomenon in the academia over the years. Discussions have concerned the game of chance, behavior of investors and computer traded automatic algorithms. Despite these hypotheses investing gurus as Warren Buffet basically try to find undervalued stocks where the fundamental value exceeds the market value of the stock why assessing the fundamental value of the company is vital. The European telecommunication sector index rose and significantly exceeded the general index in year 2000 to 2002 indicating an overvaluation or “bubble”. Does this denote that telecommunication companies cannot be valued by its fundamental value? Or how much of the value can actually be explained by the fundamental performance of the company? The main objective of this thesis is to analyze if and how much of stock market price in the telecommunications sector that can be explained by fundamental values. Analysis is performed on the European market with data from Q1 2000 to Q2 2010. Six value drivers affecting share value was analyzed; sales growth rate, operating profit margin, income tax rate, working capital investments, fixed capital investments and cost of capital. When fitting the change in value drivers to stock price by ordinary least squares a majority of the parameters ended up insignificant. Two major reasons of this result have been identified; the model is insufficient in identifying fundamental value or the fundamental value can only explain a minor part of the fluctuations in stock prices. The model could be enhanced by including sector specific value drivers in the analysis or by using a more advanced estimation model. Assuming the estimation performed in this thesis is sufficient approximately 23% of the stock market fluctuations are explained by fundamental value. Furthermore, the most significant value drivers are cost of capital and income tax rate.