3/18/12

Franklin Resources is likely overvalued

Here we present a new price model for Franklin Resources (NYSE: BEN).  BEN is a financial company and  we analyzed it three years ago as a candidate for  bankruptcy.

We presume that any share price can be represented as a weighted sum of two consumer price indices (not seasonally adjusted in our model) which may be leading the share price by several months. Our model also includes a linear time trend and an intercept in order to remove mean and trend components from all involved time series.  The intuition behind our pricing model is obvious – we link a given share to those goods and services which are produced/provided by the company. In order to provide a dynamic reference we also introduce in the model some relative and independent level of prices (also expressed by CPIs). Hence, one needs two different CPIs to define the model. These CPIs we select from a big set of 92 CPIs by minimizing the residual model error.

The current BEN model is driven by the consumer price index of food at home, FH, leading the price by five months and the index of other goods and services, O, which leads by nine months:

BEN(t) = -5.47FH(t-5) – 1.81O(t-9) – 59.55(t-2000) + 1327.36, February 2012

where t is calendar time.  The standard error between July 2003 and February 2012 is \$7.55.

The BEN model includes almost the same CPIs as the model for Apartment Investment and Management Company (NYSE:AIV), which we presented several days ago. For AIV, the index of food and beverages is defining instead of the index of food at home, but the difference is very small:

AIV(t)= -2.57F(t-5) - 0.41O(t-6) +20.51(t-1990) + 520.76, February 2012

Both models allow prediction at a five month horizon.

It is interesting to compare the overall evolution of both prices since 2003 and to understand their similarities and differences. Figure 1 displays both prices as they are. Their shapes are mainly similar but the amplitudes are quite different. Figure 2 depicts the same curves but normalized to their respective peak values between 2003 and 2012. The similarity and the presence of a sharp fall in October-November 2008 are obvious. This might be the reason behind the similarity in defining CPIs and the time lead. In any case, it is very important to have a hint on the future fall in the prices five(!) months in advance, as it was in 2008.

Figure 1. The evolution of BEN and AIV share prices.

Figure 2. The evolution of BEN and AIV share prices, both normalized to their peak values beteen 2003 and 2012.

Here we present the new BEN model in a standard way. Figure 1 shows the evolution of both defining indices between 2002 and 2012. Figure 4 depicts the observed and predicted monthly closing prices since 2003 and also provides an estimate of the model natural uncertainty as related to the high/low monthly prices. The real time prediction (green curve) leads the observed price by 5 month. As for AIV, all major turns in the price were well foreseen by the model, including those in April 2007, May 2009, and May 2011. The residual error is also shown in Figure 5 with standard deviation of \$7.55.

Figure 5 shows that BEN price is likely overvalued (same for AIV). One might expect that BEN shares will likely to fall slightly in the second quarter of 2012 and then will stay at \$105.

Figure 3. The evolution of defining CPIs.

Figure 4. Observed and predicted BEN share prices together with the high/low monthly prices.

Figure 5 . The residual model error.