1

Wesfarmer invests in a wide range of markets thus make its portfolio more diversified which
explain the considerably lower Beta than Rio Tinto
Nature of business of Rio Tinto make it metals and mining which means there is considerably
more inherent risks than Wesfarmers which is Australia largest retail group
Those above factors explains Wesfarmers lower volatility which translate into lower
earnings expectation and this is an anticipated result
2

Formula: Ri = Rf + Beta * (Rm-Rf)
As we can see above, both these stocks are performing better than they are expected to, therefore
they lie above the SML and are undervalued stocks. According to this analysis, investors should buy
these shares
3
Rio Tinto is expected to generate: Ri = Rf + Beta * (Rm-Rf) = 15% return p.a

Using Dividend Discount Model to valuate Rio Tinto, the company share price is at $11.29 which is a
huge gap to the actual share price of $61 in March 2014. This variance can be explained by the
drawbacks that are inherent in the model itself:
- Not directly linked to value creation process
- Dividend decision is at Board of Directors discretion and could very well be volatile
- When used for longer-term analysis, the valuations provided by dividend discount models
take no account of the possibility of a deliberate change to a companys dividend policy. This
can further compromise the usefulness of dividend discount models over the longer term.
2/2014 1/2015 2/2015 1/2016 2/2016 1/2017 2/2017 1/2018 2/2018 1/2019 2/2019
Dividend Discount Model
1. Di vi dend
(cents) 120.14 155.20 200.48 258.98 334.56 432.18 558.29 721.20 931.64 1203.50 1554.68
2. Esti mated cost of capi tal for equi ty 15.00% 1.08 1.15 1.23 1.32 1.42 1.52 1.64 1.76 1.89 2.03
3. Di vi dend growth pattern 29.18% 29.18% 29.18% 29.18% 29.18% 29.18% 12.00% 12.00% 12.00% 12.00%
4. Termi nal Val ue of Di vi dend 31,054.79
5. Di scount di vi dend stream 1,897.16 144.37 174.33 211.42 254.05 305.29 366.86 440.84
Di scount TV 18,982.73
Equi ty Val ue ($m) 20,879.89
Total No. of Share Outstandi ng (m) 1,849.67
Share pri ce 11.29 $
Rio Tinto Valuation
Rf 0.08
Rm 0.15
Beta Ri Actual Var
RIO 1.29 0.1703 0.174 0.37%
WES 0.68 0.1276 0.138 1.04%
- Dividend discount models rely heavily on the validity of the data inputs, making them of
questionable value given the challenges associated with accurately forecasting growth rates
beyond five or so years.