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Stanley Works, Inc. Equity Valuation and

Analysis

Innovative Analysis By: Riley Teaff r.teaff@ttu.edu

John Hohlier john.hohlier@ttu.edu

Chris Booras chris.booras@ttu.edu

Josh Ziegler josh.ziegler@ttu.edu

Trevor Willis thw5722@gmail.com

Paul Scheurer paul.scheurer@ttu.edu

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TABLE OF CONTENTS Executive Summary 3 Business & Industry Analysis 9 Company Overview 9 Industry Overview 11 Five Forces Model 13 Rivalry Amongst Exiting Firms 13 Threat of New Entrants 19 Threat of Substitute Products 21 Bargaining Power of Buyers 23 Bargaining Power of Suppliers 24 Industry Analysis 26 Firm Competitive Advantage Analysis 29 Key Accounting Policies 33 Potential Accounting Flexibility 40 Actual Accounting Strategy 43 Qualitative Analysis of Disclosure 44 Quantitative Analysis of Disclosure 46 Sales Manipulation Diagnostics 47 Expense Manipulation Diagnostic 53 Potential “Red Flags” 60 Coming Undone (Undo Accounting Distortions) 61 Financial Analysis, Forecast Financials, and Cost of Capital Estimation 62 Financial Analysis 62 Liquidity Analysis 62 Profitability Analysis 74 Capital Structure Analysis 80 IGR/SGR Analysis 84 Financial Statement Forecasting 86 Analysis of Valuations 97 Method of Comparables 97 Cost of Equity 103 Cost of Debt 105 Weighted Average Cost of Capital 106 Intrinsic Valuations 108 Discount Dividends Model 108 Free Cash Flows Model 109 Residual Income Model 110 Long Run Return on Equity Residual Income Model 112 Abnormal Earnings Growth Model 114 Credit Analysis 117 Analyst Recommendation 118 Appendix 119 References 142

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Executive Summary Investment Recommendation: Fairly Valued, Hold/Buy (11/1/2007)

NYSE:SWK $57.55 Altman Z-Score 52 Week Range: $48.61-$64.25 2002 2003 2004 2005 2006Revenue: $4,018.60 M 4.50 4.18 4.61 4.83 3.96 Market Cap.: $4.19 B Shares Outstanding: 82.2 M Valuation Estimates % Institutional Ownership: 78.50% Actual Price (11/1/2007): $57.55 Book Value (Per Share): $21.74 ROE: 18.65% Financial Based Valuations ROA: 7.36% Forward P/E: $61.41 Trailing P/E: $58.34 Cost of Capital Est. R� β Ke P/B: $74.49 EV/EBITDA: $69.73 3 Mth 0.393 1.399 13.51% D/P: $79.15 1 Yr 0.392 1.399 13.61% P.E.G.: $58.41 2 Yr 0.391 1.401 13.53% P/FCF: $58.11 5 Yr 0.390 1.399 13.71% P/EBITDA: $68.95 7 Yr 0.390 1.399 13.81% 10 Yr 0.390 1.399 14.01% Intrinsic Valuations Discounted FCF: $78.86 Published β 1.4 Discounted Dividends: $69.59 Kd (BT) 4.77% Residual Income: $40.17 WACC (BT) 10.31% Long-Run RI Perpetuity: $27.18 WACC (AT) 9.95% AEG: $44.31

Print chart

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Industry Analysis

In 1843 a man had a small shop, a couple pounds of wrought iron, and a

dream. A dream to create a business that would strive for customer service and

quality while making door hinges and bolts for locals in New Britain, Connecticut.

That man’s name was Fredrick Trent Stanley, and today his company lives on still

known as its original name, The Stanley Works. One-Hundred and Sixty-Four

years later, the company has become one of the leaders in innovative products

and quality service for its customers. With sales in more than 130 countries,

Stanley continues to expand its customer base and develop critical relationships

with its dealers.

An industry as large and expanding as this one, there is no shortage of

competitors. Stanley’s main competitors include the likes of Danaher, Black and

Decker, and Snap-On to name a few. Firms in this industry compete on

specialization and innovation, as well as price, customer satisfaction, and brand

imaging. This line of competition allows for some threat of new entrants on the

basis of local market niches, but with the extremes of innovation it makes it hard

for smaller companies to intrude. The switching costs in the industry are fairly

moderate due to the evolution of innovation.

Coupled with the presence of government patents and trademarks, the

development of new products and ideas is extremely important. Differentiating a

product from that of competitors is the best way to build a customer base, and

Stanley strives to do just that. The task is crippled somewhat because the

company relies so much on metals to create their products, and the metals that

are used are also a commodity which drives their price up and gives the suppliers

a bargaining tool. Thus, the suppliers have moderate bargaining power in the

industry.

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The key success factors that drive the industry include quality, brand

imaging, and economies of scale. If a firm can maintain relative economies of

scale through contracts with suppliers or relationships to keep costs down, it could

compete on costs. Because this is moderately hard to do, most firms try to

maintain an association of brand image to the firm. This image will include a basis

of quality that customers will come to expect. In essence, if you can win them

over, they will come back for more.

Accounting Analysis

The overall profitability of a company doesn’t just rely on its key success

factors; it is also dependent upon which accounting policies it implements. The

presence of the Generally Accepted Accounting Principles has made these

accounting policies even more important because of the leeway that is allowed

when reporting financial statements. This leeway makes the accounting analysis

of firms even more important than in the past when analyzing its value.

Stanley’s key success factors include economies of scale, and therefore it is

important to disclose continuous growth. They do this by including the tables and

percentages in their 10-K which helps to increase transparency.

Another of Stanley’s key accounting policies is achieved through its pension

plans that it offers for its employees. One of Stanley’s key success factors is cost

control and with this in mind pension plans are an area that aggressive accounting

strategies can change figures drastically. After analyzing the pension plans of

Stanley it was determined that Stanley had a conservative accounting strategy.

This was confirmed by the continued decline in the discount rate, the increasing

compensation rate, their expected return on plan assets staying near the discount

rate, and the very transparent information provided from Stanley.

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Through the analysis of accounting policies we found no potential “red

flags” for the company, a good sign for investors. The company also had an

insignificant amount of operating leases so it was not necessary to discuss that

aspect any further. This is a good sign of the true transparency of the firm.

Financial Analysis, Forecast Financials, and Cost of Capital Estimation

With the help of a set of ratios used by analysts in the industry, it is

possible to more acutely analyze the financial statements of a company and

compare them to competitors. These ratios are used to evaluate a firm’s liquidity,

capital structure, profitability, and to help aid in forecasting the financials to get a

look at the future. We can then conclude by instituting a regression model to find

an applicable Beta to calculate the firm’s cost of debt and equity, and its weighted

average cost of capital; all of which are fundamental in the processes of

evaluation.

Through the liquidity analysis of Stanley it was determined that it is a liquid

firm. Using the current ratio, quick asset ratio, accounts receivable turnover,

inventory turnover, days supply of inventory, and working capital turnover we

discovered several things about the liquidity of the firm compared to its

competitors. Stanley was either leading or above average in all of these ratios.

Stanley was above average in the quick and current ratios meaning that they had

more of a cushion in case of immediate payment of current obligations was

needed. This also is a good mark that the firm is healthier than the rest of its

competitors. Using the profitability ratios it was determined that Stanley on

average outperforms the industry. Stanley showed excellent performance during

2003 and 2004, due to increasing economies of scale through acquisitions and

experiencing relatively high sales growth. In recent years profitability has slowed

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some but by consistently outperforming the industry average, Stanley continues to

maintain a strong ability to efficiently create profits.

By analyzing the past few years of financial statements forecasts were

made for Stanley Works next ten years. Observing income patterns in Stanley and

comparing to the industry average, a growth rate of 7.5% was assumed. After

forecasting sales, the asset , inventory turnover, and account receivable ratios

were used to help in forecasting all relative items in the balance sheet including

total assets. Finally, the statement of cash flows was forecasted by comparing it

to the net income and a trend was found with CFFO/Sales. The past three years

of CFFO/Sales were averaged to 11.5% and that was used to forecast the cash

flows from operating activities.

Valuations

With the use of several intrinsic valuation models and comparable methods,

one can get fairly accurate idea about how a firm is valued and whether or not the

current market value is undervalued, fairly valued, or overvalued examining the

calculated share prices from each model, but only a couple of the models can be

relied upon having fairly accurate results.

The method of comparables was used as a quicker screening tool to get a

better look at Stanley Work’s value of equity or stock prices. All comparables

showed that Stanley Work’s was fairly valued, or under valued without throwing

out possible outliers. The comparable prices ranged from $58.11 -$79.15

When using the discounted dividends one must understand how unreliable

the calculated results can be. As a result of the dividends that Stanley pays out

every three months, the estimated share value was $69.59. As for the next

model, which is as unreliable as the last, ran a valuation on the free cash flows

and calculated a price per share of $78.19. Now for a more accurate model, the

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residual income model, that uses forecasted earnings to value the firm. The price

per share given was $42.70. Next ,the long-run residual uses a calculated long-

run growth rate (-.015) and long-run return on equity (.17) at perpetuity valued

Stanley’s share price to be $34.60. Finally, the last valuation run was the

abnormal earnings growth which is derived from the P/E ratio and associates the

valuations with the residual income model. This model had a final calculation for a

price per share to be $45.50. With two conflicting models it is hard to say how

the firm is valued, but observing slight changes ROE, cost of equity, and growth

rates, Stanley Works comes to be a fairly valued company.

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Business & Industry Analysis

Company Overview

Stanley Works, Inc. [SWK] is one of the world leaders in the machine tools

and accessories industry. In 1843, Fredrick Trent Stanley opened a shop in New

Britain, Connecticut where their corporate office still remains today. Over the last

163 years, the company has become one of the leading worldwide tool

manufacturers and distributors. Stanley works, Inc. operates through

manufacturing, distribution, and sales offices and warehouses in seventeen states

and thirteen foreign countries.

Stanley Works, Inc. can be broken into three segments: consumer

products, industrial tools, and security solutions. Through these channels Stanley

provides professionals, industries, and consumers with a variety of tools and

security devices. Products produced by Stanley range from hand tools to

demolition tools to sliding doors. Stanley strives to produce and deliver the very

best and to be founded on the basis of quality, commitment to customer service,

expansive product lines, and innovation to create a brand known worldwide. It

states in the company website, “the Stanley name is known around the world as a

reliable guarantee of quality and value” (www.stanleyworks.com).

Stanley works, Inc. is one among 1500 large and small companies

competing in a fairly concentrated market. However, Stanley can be classified

with other top competitors such as: Black & Decker Corp. [BDK], Danaher Corp.

[DHR], and Snap-On, Inc. [SNA]. Stanley currently holds a market cap of 4.44

billion dollars. Both Black & Decker and Danaher exceed this market cap while

Stanley remains higher than Snap-On. The firm is currently growing year after

year in an industry that has moderate growth and fights for market share. Stanley

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is traded on the NYSE and has stock price growth comparable to the S&P 500

Index. Stock prices for Stanley Works, Inc. have shown an increase of about 70

percent over the past five years.

Chart created by www.moneycentral.msn.com

Stanley claims to be in a position where “profitable growth is a fundamental

expectation rather than simply a desirable objective” (Stanley Works Annual

Report). This idea is backed by year over year sales growth and a 12 percent

increase in sales from 2005 to 2006. Sales can be driven by Stanley’s continual

new line of products, acquisitions, and innovations.

Total Assets, Net Sales, and Growth

2002 2003 2004 2005 2006 Total Assets

$2,418.00 $2,424.00

$2,851.00 $3,545.00 $3,935.00

Net Sales

$2,187.00 $2,485.00

$2,997.00 $3,285.00 $4,019.00

Growth in Net Sales .23% 13.63% 20.60% 9.61% 22.34% Value’s expressed in $millions

Source: StanleyWork 2006 ARP

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Industry Overview

The machine tools and accessories industry can be divided into many

segments. Most company’s focus on one specific segment or work in a specially

area of the industry. Competition and threat of low cost substitute products have

driven many companies in this industry to compete worldwide. Stanley Works,

Inc. is in the Machine Tools and Accessories industry. This is because they provide

a wide variety of tools for both household consumers and industrial consumers.

Among this segment are the top competitors as previously mentioned: Black and

Decker, Danaher, and Snap-On. This specific industry has a total market cap of

$14 billion (finance.yahoo.com). In this fairly concentrated market, the 50 largest

companies hold 65 percent of the market share and a third of the companies are

considered to be small (firstresearch.com).

The industry’s demand is determined by other industries such as the

construction and building industries. Profitability is determined by the firm’s ability

to produce efficiently, innovation, technology, and automation. Larger companies

are able to have economies of scale in purchasing and production while smaller

companies can compete in a specialty area of the industry. Parts of this industry

rely heavily on “big box stores” such as Home Depot and others. Home depot

alone accounted for 10 percent of Stanley’s sales in 2006.

In this type of industry Stanley has sought to work in three different

segments. As previously stated, those segments are divided as follows: consumer

products, industrial tools, and security solutions. Consumer products are one

segment where innovation and brand name is valued. The consumer products

segment was roughly 16 percent of net sales which was a 21 percent increase

from 2005. This is a segment where market share is important. Stanley was able

to increase share by releasing a new line of products in 2006, the Fat Max XL and

the Fat Max Xtreme.

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The second segment is the industrial tools segment. This segment provides

commercial equipment such as hydraulics and others such as heating and air

conditioning. Its primary focus is on the professional industries in the market.

This segment was about 9 percent of Stanley’s net sales.

The third and last segment is the security solutions. Its focus is to provide

security solutions “primarily for retailers, educational and healthcare institutions,

government, financial institutions, and commercial and industrial customers”

(www.sec.gov/archives/stanleyworks). These solutions range from automatic

doors, locking systems, and other various security devices. This segment accounts

for about 15 percent of Stanley’s net sales.

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Five Forces Model The Five forces model is a tool that helps analysts determine the

competitive intensity and profitability potential of an industry. The five forces

model examines the rivalry of existing firms, the threat of new Entrants, and the

threat of substitute products to gauge the level of actual and potential competition

in a particular industry. The five forces model also examines the bargaining

power of buyers and suppliers in the industry to further assess the profitability of

firms competing in a particular industry.

Rivalry Among Existing Firms

The machine tools and accessories industry is highly competitive. As a

result of low switching costs, and market consolidation in the industry, companies

are forced to aggressively compete for market share. Existing companies compete

on the basis of product quality, product innovation, price, and customer service.

Firms competing in the industry must focus heavily on product quality and

innovation, while at the same time maintaining a low-cost structure in order to be

successful.

Rivalry Among Existing Firms

Threat of New Entrants

Threat of substitute products

Bargaining Power of Buyers

Bargaining Power of Suppliers

High

Low

High

High

Moderate

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Industry Growth

Industry growth is a key determinant of the level of competition companies

in an industry face. Industries plagued with stagnant growth force competing

firms to fight for market share often resulting in price-wars. However, firms in

industries experiencing rapid growth do not have to fight for market share. As the

industry increases, individual market share increases as well. The machine tools

and accessories industry is experiencing normal growth. Firms already in the

industry often look to expand market share further through mergers and

acquisitions, as well as diversifying into other business segments to capture a

larger customer base.

Based on net sales per company

Concentration

The industries concentration is determined by the number of firms

competing in that industry. The level of concentration in an industry can greatly

affect a firms control over prices and a firm’s competitive position. An industry

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that is highly concentrated has only a few key players competing for market

share, giving them control over their prices. In contrast, an industry that has a

low concentration of firms competing in the industry have little or no control over

their prices and are usually driven into price battles with competitors. The

machine tools and accessories industry is fairly concentrated allowing firms some

control over their prices and competitive position, while still having to aggressively

compete with their competitors.

Based on Net Sales for SWK, DHR, BDK, and SNA

Differentiation and Switching Cost

Firms in the machine tools and accessories industry place a great deal of

emphasis on differentiating themselves from their competitors. In order to stay

competitive, firms must continue to innovate and keep up with new technology.

Firms in the industry focus heavily on product innovation and product quality

through extensive research and development in order to differentiate their

products and gain an advantage over their competitors. Firms in the industry

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have a relatively low switching cost due to the similarities of the products being

offered. Switching cost represent the actual cost and opportunity cost associated

with switching from one firm to another. In the machines tools and accessories

industry, customers are able switch from one company to another fairly easily at

little or no added cost associated with the switch, resulting in price competition

among firms.

Economies of Scale

A firm’s size also plays an important role in determining how well it can

compete in an industry. Larger firms have greater bargaining power over their

suppliers giving them the ability to offer lower prices than smaller firms competing

in the industry. Larger firms are able to prevent new firms from entering the

industry as well as drive out smaller existing firms that are unable to compete

against larger companies low-cost structure. Additionally, larger firms often

possess greater intellectual capital as a result of operating experience providing

another competitive advantage. In the machine tools and accessories industry

achieving economies of scale is essential in order to stay competitive. Although

the industry is fairly concentrated, price competition does exist, making it much

harder for smaller companies to compete and new companies to enter the

industry.

*In Millions of USD

Total Assets 2002 2003 2004 2005 2006

Danaher 6,029.15 6,890.05 8,493.89 9,163.11 12,864.15

Black & Decker 4,130.50 4,222.50 5,530.80 5,842.40 5,247.70

Stanley Works 2,418.20 2,423.80 2,850.60 3,545.10 3,935.40

Snap-On 1,994.10 2,138.50 2,290.10 2,008.40 2,654.50

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Fixed to Variable Cost

The relationship between fixed and variable cost provides insight to the

degree of competition in an industry. Firms with a high ratio of fixed cost to

variable cost are less flexible in moving from one industry to another. These types

of firms often engage in price wars as a result from the need to utilize their

capacity. However, firms that have low fixed cost to variable cost are extremely

flexible in moving from one industry to another. These types of firms have the

advantage of leaving an industry when profits become undesirable. The majority

of firms in the machine tools and accessories industry have low fixed to variable

cost ratios. Firms in the industry manufacture their products and sell to retailers

or directly to their customers, resulting in a relatively low fixed cost. This allows

firms more freedom to leave the industry.

Fixed Costs to Variable Cost Ratios

*Ratios derived from the financial statements of Danaher, Black & Decker, Stanley Works, and

Snap-On, Inc.

Excess Capacity

Excess capacity occurs when there is a buildup of inventories due to a lack

of customer demand. When supply exceeds demand, firms reduce prices in order

to increase sales to eliminate the excess inventory. If industry conditions become

undesirable, firms with low exit barriers will sell off there inventories and leave the

2002 2003 2004 2005 2006

Danaher 0.513 0.480 0.442 0.414 0.402

Black & Decker 0.532 0.538 0.513 0.405 0.413

Stanley Works 0.862 0.718 0.640 0.616 0.558

Snap-On 0.672 0.650 0.627 0.628 0.578

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industry. However, firms that face high exit barriers have a more difficult time

leaving. Large firms in the machine tools and accessories industry are often able

to handle inventory buildups more effectively than smaller firms in the industry

due to economies of scale. Although firms in the industry focus on minimizing

inventory, excess capacity often occurs as a result of firms over forecasting

consumer demand. One way to measure how effective a company is at mitigating

excess inventory is by calculating a firm’s inventory turnover. A firm with a high

inventory turnover is better able to minimize their inventory and reduce excess

capacity. The graph below consists of each company’s inventory turnover

competing in the industry.

Industry Inventory Turnover

2002 2003 2004 2005 2006

SWK 3.64

4.52

4.65

4.57

4.27

DHR 5.75

5.88

5.68

5.50

5.32

SNA 3.09

3.61

3.86

4.55

4.30

BDK 3.87

4.07

3.50

4.01

3.95

Industry Avg. 4.09

4.52

4.42

4.66

4.46

Exit Barriers

Exit Barriers prevent companies from leaving the industry. Firms with high fixed

to variable cost ratios and specialized assets have a difficult time exiting the

industry. The machine tools and accessories industry is not restricted by any

major exit barrier. Although firms in the industry use some specialized

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manufacturing equipment, the majority of their assets would be compatible with

other manufacturing industries.

Conclusion

The Machine tools and accessories industry is highly competitive. Firms in

the industry need to focus heavily on product quality and innovation in order to be

successful. The industry is fairly concentrated with a relatively small number of

firms controlling the majority of market share. As the industry becomes more

consolidated firms often try to increase market share and customer base through

mergers, acquisitions and divestitures. Low switching costs and few exit barriers

in the industry has increased price competition, preventing new firms from

entering, and making it harder for smaller firms to compete.

Threat of New Entrants

The threat of new firms entering the industry is a key indicator of how

profitable existing firms will be in the future. In the machine, tools, and

accessories industry threat from new entrants is relatively low. The industry is

fairly concentrated with few large firms controlling the majority of market share.

Large existing firms such as Danaher, Stanley, and Black and Decker experience

economies of scale and have a great deal of experience operating in the industry,

making it extremely difficult for new companies to affectively compete.

Economies of Scale

The greatest challenge new firms entering the industry face is competing

on cost with existing firms. Large firms in the industry have close relationships

with their suppliers and have substantial bargaining power, giving them a cost

leadership advantage over new and smaller firms. In order for a new firm to be

successful, they would have to heavily invest in capacity to increase their scale of

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operations. New firms are also limited by economies of scale from high

investment in research and development. New firms would also have to invest

heavily in research and development in order to affectively compete in the

industry.

Total Assets

2002 2003 2004 2005 2006

Danaher 6,029.15 6,890.05 8,493.89 9,163.11 12,864.15

Black and Decker 4,130.50 4,222.50 5,530.80 5,842.40 5,247.70

Stanley Works 2,418.20 2,423.80 2,850.60 3,545.10 3,935.40

Snap-On 1,994.10 2,138.50 2,290.10 2,008.40 2,654.50

Channels of Distribution Access and Relationships

Another major problem that faces new firms entering the industry is

establishing supplier relationships. Large firms in the industry have very close

relationships with their suppliers, and often receive discounts for purchasing large

quantities of supplies. New firms entering the industry usually lack the experience

and capabilities of forming strong relationships with suppliers, and are unable to

reap the same benefits as large existing firms. Firms in machine tools and

accessories industry rely heavily on their suppliers to deliver the materials

necessary for production. For instance, Stanley uses a vast supply of raw

materials to produce their products. After many years of dealing with the same

suppliers, Stanley has developed a solid business relationship with these

companies. This relationship has improved there quality and efficiency of their

supply chain.

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Legal Barriers

The machine tools and accessories industry does not have any major legal

barriers to enter the industry. Since firms in the industry focus heavily on product

innovation, a larger number of patents do exist. However, these patents are not a

significant barrier to enter the industry.

Conclusion

The machine tools and accessories industry faces little threat from new

entrants. The industry’s concentration and large economies of scale pose the

most significant barriers for new firms entering the industry. In order for a firm to

affectively compete in the industry they must heavily invest in operating capacity,

and research and development to achieve economies of scale

Threat of Substitute Products

In industries today there will always be a threat of substitute products, and

this industry is no exception. There is a great demand in construction and

building for tools and equipment, which make it all the more difficult to stand out.

However, due to the typical background of the Stanley’s target customer, they are

extremely loyal to a brand. This creates a moderate threat of substitute products

for the Company, and a similar switching cost. Because the Company thrives on

quality, innovation, and customer service, it is hard for the consumers to find a

comparable product.

Buyers’ Willingness to Switch

A product that maintains and performs the same or similar functions is the

greatest threat in tools. While one would prefer quality to price, it doesn’t hide

the fact that there could be a more cost efficient option available. This is why it is

important for Stanley to maintain the highest of quality and innovation in the

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industry. Creating a brand image on quality can help to relinquish the customer’s

desire for a cheaper alternative. When the buyers know that the inherent quality

of the tool increases its longevity, then they can be assured of saving money in

replacement costs. This is why they are willing to pay a premium for superior

products. This goes along with the presence of Stanley’s innovation. Innovative

products allow consumers to be more efficient and productive in their work. This

is why buyers have a moderate switching cost in this industry.

Relative price and Performance

Buyers in this industry understand that you get what you pay for. The

quality of a tool or machine is based upon its material and design in relation to its

intended use. When a customer buys a low grade, less expensive wrench, they

do so knowing that they won’t be putting it too much use. However, in the

construction business, the tools and machines that are used are used infinitely.

Therefore they are willing to pay a premium for high grade products. This is what

draws the consumer to Stanley.

Conclusion

There is a wide range in degree of quality in the tool industry, from the

inexpensive low quality products, to the high end indestructible products. And

while it is possible to find a cheaper alternative, customers that intend to use a

tool for more than small, infrequent projects, are willing to pay higher prices for a

more durable good. The presence of tools that can perform similar, or the same,

functions is the biggest threat for substitute products. With a moderate switching

cost, companies that maintain a high quality standard can keep a large customer

base through brand image, customer service, and innovation.

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Bargaining Power of Buyers

Bargaining power is one of the most powerful influences a consumer has

over a firm. If the consumer has a high bargaining power, it will cause the

industry to compete on price. If this is the case, the firms in the industry must

fight to keep their costs low to obtain customers. If the consumer has a relatively

low bargaining power, then the firm can stay within their normal order of

operations without having to worry about costs.

The tool industry relies on large home centers and other mass merchants to

create the largest portion of their customer base. Because these merchants sell a

variety of products and brands, it makes it easier for them to maintain power over

the firms they buy from. With a large purchase volume, they can force companies

to lower prices, or create a brand image.

Price Sensitivity

In the tool industry firms must compete on quality, and innovation. There

is a moderate level of switching costs, substitute products, and differentiation in

the industry. The industry’s buyers must ensure that their customers are satisfied

at a reasonable price while maintaining customer satisfaction. Because of this,

buyers aren’t as influenced by the price of products when they offer the upmost of

quality and leading innovation.

Relative Bargaining Power

Due to the variance of the size of buyers in the tool industry ranging from

large mass merchants to individual customers, there is a range in degree of

bargaining power of these clients. The overall size of the client’s orders, and the

frequency of those orders, will gain more power in the bargaining process. The

larger home centers definitely have an edge in their ability to drive down costs

when purchasing from the tool industry. However, if their customers show loyalty

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to a brand, it could take away some of the advantage the home centers would

have over the firms. Moving down the chain to individual buyer lessens the

amount of bargaining power obtained. Individual buyers will have almost zero

bargaining power when trying to buy from the firms

Conclusion

The bargaining power of buyers in the tool industry can vary greatly. The

overall size of the buyer can give them an advantage when bargaining, and allow

them to be more price sensitive. Their high quantity orders and frequency of

orders gives them the power. On the other hand you have the individual buyers,

and smaller companies. These have close to zero bargaining power, and can

become less price sensitive due to this. If the tool firms can maintain their edge

in quality and brand image, it will keep the buyers from achieving a higher level of

price sensitivity and bargaining power.

Bargaining Power of Suppliers

Looking at the bargaining power of firm’s suppliers is a lot like looking at

that of the buyers. The fewer the amount of suppliers, the more power they will

have over the firm. And the more necessary the materials are to the firm, the less

they will be able to haggle on price because these materials are the main

ingredient in creating the tools they sell. Stanley is in a good position with

suppliers because there are many to choose from that all offer competitive prices.

Stanley needs materials such as metals, plastics, wood, and other packaging

materials. Stanley uses varying time contracts with suppliers to lock them into

reasonable, negotiable prices.

Suppliers lose more of their power with the raw materials because some of

these materials that Stanley uses, such as the metals, are commodities as well.

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This means that there are a large number of suppliers to match the large number

of buyers, keeping competition amongst these suppliers high, so Stanley’s cost of

switching suppliers is low. With these costs of raw materials staying low, Stanley

is able to keep profit margins high and increase their power over suppliers.

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Industry Analysis To become a successful company in the machine tools and accessories

industry you must be able to compete on many factors. Some companies

compete on low-end, low-priced goods and are successful. However, the industry

as a whole competes on differentiation, putting emphasis on the following

concepts. In this industry a company must diversify their products and services

in order to gain customer value. To gain an advantage, a company’s research and

development team must be superior to keep up with new product and services in

the industry. This can be done not only through research and development, but

acquiring technology that can improve a product and services’ quality and/or

performance. Furthermore, most leaders in this industry have been around for at

least a century which ultimately has created competition in making customers

aware of different brand names.

Product Quality and Variety

As all companies know, having a variety of products in this industry is a

must due to an array of similar brand name products. Research shows that the

majority of consumers want a reliable and quality product at a reasonably

affordable price. This is of great importance to the machine tools and accessories

industry since earnings have declined over the last year due to a lack of request

for building materials which the industry blames on the “weak U.S. housing

market and weaker demand for discretionary goods” (online.wsj.com). This

industry can provide such products because of the research and developments of

new product lines. This is achieved by advancements in technology for new

machinery, design programs, and corporate strategies which in return provides a

more efficient process in all facets of production and distribution, such as,

obtaining lower cost materials, decreasing production time, creating innovated

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products, while creating value and maximizing profits. As a result, there are

numerous companies that produce their own brand of products. This allows

companies to differentiate themselves from competitors in hope of becoming an

industry leader in product quality as well as cost.

Not only is quality important, but having a large variety of products and

services is essential in establishing a respectable reputation in this industry.

Companies do this by product differentiation; consumers are presented with a

wide scope of products and services because of advancement in existing tools and

accessories, an introduction new product lines, and offering a different quality

products at various costs. Having done this, other companies are striving to catch

up in the industry while others are taking away a portion of their customer base.

“After all, innovation is the only way to create wealth over the medium-term …

and in the longer-term, there are no substitutes to innovation.”

(businessinnovationinsider.com).

Brand Awareness

In this industry, most of the leading companies have been around for at

least a century. Meaning, for a company to further differentiate themselves they

must have a recognizable and reputable brand image to draw in new customers

while keeping its current customers. In order to have a reputable brand,

companies expand by acquiring multiple franchises to promote themselves in all

segments of the industry, allowing customers to trust and rely on their preferred

brand. Patents are used in a similar way, but are short lived in this industry (20

years). Having patents on various products provide the company with

differentiation in their products knowing that the uniqueness and innovation of its

product are legally theirs.

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Research and Development

Research and Development Costs (In Millions of USD)

In this highly competitive industry in order to compete, companies must

stay ahead of the competition by developing newer and innovated products. To

be able to do this research and development is crucial in knowing what the

consumers want, how much they are willing to pay, and how satisfied they are.

Technology is continuously changing requiring companies to evolve and create

unique and innovated products. Customer feedback on products is widely used to

increase customer satisfaction by addressing requests for product changes, ideas,

and to better understand the different types of customer bases are in this

industry. The more feedback, the more satisfying a product becomes through

quality and effectiveness.

2002 2003 2004 2005 2006

Danaher $174.00 $207.00 $294.00 $379.00 $446.00

Black &

Decker $94.30 $100.40 $118.60 $133.80 $139.40

Stanley Works $8.70 $10.10 $13.20 $14.50 $15.30

Snap-On $57.10 $59.80 $45.70 $50.00 $45.70

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Competitive Advantage Analysis

For several years, Stanley Works “has focused on a profitable growth

strategy and begun to transform itself from a mature 160 year old ‘American tool

company,’ to an innovated, multi-national, diversified, industrial growth business”

(Stanley Works 10-k). More than a decade ago, Stanley Works began another

transformation to a modern day tool business from multiple acquisitions,

diversifying, reducing risk associated with large customer bases, and further

developing its brand image. Additionally, Stanley Works seeks growth in its

security segment while continuously broaden the awareness of their brand name

tools and hardware.

Customers

Customer satisfaction has long been a goal for Stanley Works from the time

it was established in 1843 until today, and continues into the company’s future.

Using it strengths, Stanley has created the Stanley Fulfillment System (SFS) where

it progressively strives to strengthen its customer service, quality, and reduce

costs. “It’s a continuous improvement program focused 100% on the needs of

our customers and a comprehensive business system that guides the way we work

every day. SFS is our blueprint for success and our roadmap for continued

growth” (stanleyworks.com). Starting in 2007, the company is looking to expand

across its enterprise with expected increases in its working capital turnover,

decreases in their cycle times, and further increases in customer satisfaction.

Diversification and Cost Reduction

Beginning in 2002, Stanley Works has been actively working to expand by

making around $2 billion in acquisitions. Such acquisitions have consisted of

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National Manufacturing Corporation, Facom Tools, and Besco Pneumatic

Corporation.

National Manufacturing Corporation is well-known hardware business

which has been incorporated into Stanley’s own builders' hardware business and

by doing has expanded their global presence in Canada and Mexico. This

transaction has “also significantly diversify Stanley's hardware customer base

which, prior to this transaction, was highly concentrated … It also meets the

company's criteria for return on capital employed” (phx.corporate-ir.net).

As for Facom, it is a European manufacturer of hand and mechanical tools

worth $500 million. By acquiring Facom, Stanley has obtained 12 Facom research

and development offices with a strategy for innovation. Furthermore, it has

become a leader in France, Italy, and Benelux, enabling them to further diversify

products and geographic presence in its industry.

Last, the Besco corporation has become the a leader in manufacturing

pneumatic tools and Stanley’s supplier of over half their 2005 sales.

Headquartered in Taiwan, Besco “possesses state-of-the-art research and

development capabilities and efficient production facilities” further diversifying

their products and the Stanley brand (Stanley 10-k).

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The table at the bottom of the previous page represents the impact of

Stanley Works’ acquisitions in 2005. As presented, it can be noticed that Stanley’s

net sales have increased from 21% to 32% respectively from the year 2005 to

2006. As Stanley continues diversify its company, it’s expected to gain greater

advantages in the differentiation of its products, locations, and services.

Brand Image

The Stanley brand image is one of the most crucial and most valued asset

for the company. Stanley has been achieving a well-known brand image through

various strategies such as increasing brand support in 2006, 2005, 2004, in

television advertising campaigns of new products, sponsorships in sporting events

like NASCAR, and multiple web-based advertisements. Acquisitions of other well

recognized companies like FatMax, Facom, National Hardware, and Besco have

continued to broaden and increase their customer base. Stanley Works has

received multiple awards for their product innovation including the Golden

Hammer award three consecutive years and Popular Sciences’ Innovation of the

Year award for the hurriquake nail, which was designed to in order to reinforce

structures to enable them to withstand hurricane type winds (stanelyworks.com,

popsci.com). These brand advertising campaigns have generated one billion

dollars annually in brand impressions and increased their brand awareness by

30% with expectations of similar growth in the future (Stanley 10-k). From such

a reputable and recognized brand, Stanley Works is able to maintain a competitive

advantage in their industry and continues to strengthen their brand loyalty.

Even with Stanley’s reputation for quality and value, the company still faces

risk involved with “unauthorized imitation of its products or unauthorized use of its

trademark rights … causing significant damage to its brand name and reputation“

(Stanley 10-k)

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Conclusion

As for mentioned, Stanley Works continues to gain competitive advantages

in its industry from multiple acquisitions, diversifying, reducing risk associated with

large customer bases, and further developing its brand image. Furthermore,

being a top innovator in the machine tools and accessories industry keeps Stanley

ahead of their competitors and keeping a competitive advantage. Finally,

following the Stanley Fulfillment System increases customer service and eliminates

waste; keeping costs down, allowing Stanley to offer quality products at a

reasonable price.

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Key Accounting Policies

A company’s key accounting policies are the accounting methods that

directly affect a company’s key success factors. A company’s key success factors

are the factors that add the most value to the firm, and enable them to effectively

compete in their industry. For Stanley, their key success factors are economies of

scale, Product quality, product innovation, and cost control. Firms competing in

the industry have to remain committed to achieving economies of scale through

continuous growth, maintain a successful brand image through product quality

and innovation, and mitigate costs in all areas of the firms. Listed Below is

Stanley’s key accounting policies derived from their key success factors.

Continuous growth

Competition and slow sales growth in certain business segments, have

forced companies to become more cost competitive and diversify into other

markets through acquisitions. Through acquisitions, firms are able to increase

their economies of scale, and bargaining power with their suppliers. By increasing

the scale of operations firms can decrease their total cost by allocating their fixed

cost over more production units. Since 2002, Stanley has focused heavily on

growing their company, adding approximately $2 billion of acquisitions. This

increase in assets has further increased the company’s economies of scale, and

has allowed them to compete more aggressively on price. These acquisitions have

also increased Stanley’s profit margins, and have been the driving force behind

the company’s growth in sales. The chart below illustrates the enormous impact

these acquisitions have had on Stanley’s growth over the past five years.

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Acquisitions for Stanley have drastically increased over the past five years,

with its largest number of acquisitions accruing in 2006. Over 29 percent of total

assets listed in 2006 are made up of goodwill from the purchases of these

acquisitions (Stanley’s 2006 Annual Report). Stanley estimates the level of

goodwill and other intangible assets based on the best information that it has

available to them at the time of the purchase (Stanley’s 10-K). Due to the

difficulty of valuing intangible assets such as goodwill, incorrect estimations could

have an enormous impact on the company’s total assets. Furthermore, the

company has not recorded any impairment losses of goodwill or other intangible

assets for many years, as result the company’s expected profitability, and free

cash flow estimates could change as well, limiting their growth potential (Stanley’s

2006 10-K).

In order to finance these acquisitions and continue to grow, Stanley uses a

combination of free cash flows, debt and equity linked securities, as well as issuing

common equity. While the majority of these acquisitions are financed using cash

generated by the firm, large acquisitions require debt financing and the issuance

$-

$500.00

$1,000.00

$1,500.00

$2,000.00

$2,500.00

$3,000.00

$3,500.00

$4,000.00

$4,500.00

2002 2003 2004 2005 2006

Net Sales

Total Assets

Acquisitions

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of common equity. In order to continue to finance these large acquisitions Stanley

has had to remain committed to their current credit rating by refinancing using

debt and common stock. This is a key accounting policy because the growth

Stanley has experienced over the past five years, due to these acquisitions, has

been the largest contributor to Stanley’s Success. The manner in which Stanley

manages these acquisitions will ultimately determine their success in the future.

Product defects after sale

For manufacturing firms competing on product quality, it is important to

minimize the level of defective products that are sold. Stanley provides many

product and service warranties which varies across its different business

segments. These warranties generally range from one year to limited lifetime,

while some of the company’s products (mainly consumer products) carry no

warranty at all. Warranty liabilities for Stanley are calculated by forecasting the

companies expected warranty payments. This number is just an estimate, and is

0

5

10

15

20

25

2002 2003 2004 2005 2006

Provisions for Warranties Actual Warranty Payments

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often slightly over-forecasted for Stanley. Due to over-forecasting errors, the

company has to recalculate its financial statements at the end of the fiscal period

to reflect the accurate amounts. This is a key accounting policy because the

number of warranty payments can significantly impact a firm’s ability to compete

on product quality, and manipulation of warranty provisions can alter the

performance perception of the company. The graph on the next page shows

Stanley’s provisions for warranty and actual warranty payments for the past five

years.

Pension Plans

With cost control as one of our key success factors pension plans is an area

that aggressive accounting practices can lower the transparency of the financials

and change the amounts on the financial statements significantly. First of all,

pension plans can be basically defined in two separate categories. The first is a

defined benefit pension plan where the employee knows what he/she will receive

upon retirement. Then there is defined contribution plan, which is where a

company either matches contributions the employee makes or contributes a

certain amount. In the defined contribution plan however, the company does not

guarantee the benefit upon retirement. In Stanley’s case they use a defined

benefit plan for most “domestic hourly and certain executive employees, and

approximately 7,500 foreign employees. Benefits are generally based on salary

and years of service, except for U.S. collective bargaining employees whose

benefits are based on a stated amount for each year of service” (Stanley works

10-k). Additionally Stanley also uses a defined contribution plan, and ESOP

(employee stock option plan) in some cases. It is difficult for any company to

determine what rates and figures to use in determining present value of future

assets and liabilities. There are many factors to take into account when

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determining the amount in which to allocate to a pension fund to be able to pay

off pension obligations. First, the company must identify what discount rate to

use when calculating the predicted amount needed for pension obligations. The

next thing that they must determine is the expected return on assets that are

used to pay the pension obligations as the employees retire. The final part to

determine is the change in salary that occurs as time passes and the population of

recipients of these pension obligations. How the company goes about determining

these factors can have a very large effect on the company’s financial statements.

When looking at pensions plans you can basically break it up as pension

assets and pension benefit obligations. The pension assets are the account that

the company makes investments for to be able to pay off the pension obligations

(which are the estimated amount that they will have to pay). The fair value at the

end of 2006 of Stanley’s pension assets was $112.2 million and the benefit

obligation at the end of 2006 was $148.2 million. This means that Stanley has an

under funded pension plan by $36 million.

(in millions) 2002 2003 2004 2005 2006benefit obligation at year end 144.1 52 60.8 154.2 148.2

fair value of plan assets at end of plan year 121.6 13.3 17.2 101.8 112.2

funded status -22.5 -38.7 -43.6 -52.4 -36

This table shows that over the years Stanley has continued to be under

funding their pension fund which decreases owner’s equity. “Once a company

determines that its plan is under funded, it need not make up the shortfall

immediately. Federal pension laws force companies to make contributions if the

defined benefit plan's funding averages less than 90 percent over three

consecutive years or 80 percent in one year”. Companies have three to five years

to replenish the pension plan, and often they can issue more equity instead of

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paying cash” (http://www.clevelandfed.org). However, this under-funded account

does not show up as a liability on the balance sheet. There is unrecognized prior

service costs and unrecognized net actuarial loss that boost this negative number

into a positive amount. However, this seems to be a norm in the machine tools

and accessories industry. Black and Decker, Danaher, and Snap on all had an

under-funded account for pensions over the past five years, and all three of the

companies also hid this negative number by “smoothing out” this number with

unrecognized cost and loss accounts. Potentially looking at this information that

Stanley, and the three competitors have had a continuous negative funded status

it might “require increased cash contributions in the future and foreshadows

future increases in income statement expenses” (www.investopedia.com). There

are ways that companies can increase their funded status without changing

anything but a percentage rate. If a company wants to do this than all they have

to do is “either increasing the discount rate or lowering the projected rate of

salary increases.” (www.investopedia.com) The following tables show the discount

rate of pension costs, rate of compensation increase and expected return on plan

assets for Stanley and its competitors:

(discount rate) 2002 2003 2004 2005 2006 Stanley 6.50% 7% 6.00% 5.75% 5.50% Black and Decker 6.10% 5.50% 6% 6% 5.75% Danaher 7.50% 7% 6% 5.75% 5.50% Snap On 6.70% 6.50% 5.90% 5.70% 5.30%

(rate of compensation increase) 2002 2003 2004 2005 2006 Stanley 4% 4% 6.00% 5.50% 6.00% Black and Decker 3.90% 3.90% 4% 4% 4% Danaher 4% 4.00% 4% 4% 4% Snap On 3.70% 3.30% 3.00% 3.10% 3.10%

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(expected return on plan assets) 2002 2003 2004 2005 2006 Stanley 9% 8% 8.00% 7.75% 8.00% Black and Decker 8% 7.75% 8.75% 8.75% 8.75% Danaher 9% 8.50% 8.50% 8% 8% Snap On 8.20% 8.30% 8.30% 8.30% 8.20%

As you can see from the previous three tables Stanley, along with the three

competitors actually decreased their discount rate and increased their rate of

compensation. This drop in discount rates and increase in the rate of

compensation is what leads to the under-funded pension plan. Stanley shows

conservative accounting techniques when it comes to pension plans. They

continued to lower the discount rate while continuing to increase the rate of

compensation. Stanley also kept the expected return on plan rate pretty close to

the discount rate. All of these factor point towards conservative accounting

tactics. While the three competitors decreased the discount rate and kept the

expected rate of return near the discount rate; they did not increase the rate of

compensation by an significant amount or at all. Other than that difference it

seems that the companies in this industry are closely related in determining

discount rates and expected return. Another issue when it comes to paying for

the pension plan is how much equity to use to pay for the pension obligations.

Stanleys target to pay off pension obligations is to use 30%-50% in fixed income

securities. Paying with too much equity could result in a boost in the actual and

expected returns. Stanley is currently paying with around 32% of fixed income

securities, but that had decreased from the previous year. As long as Stanley

doesn’t continue to decrease too far into the future they should be alright,

however it is something to keep an eye on.

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Conclusion

As you can see throughout Stanley’s 10-k reports over the past five years

there was adequate disclosure relating to the financial figures from year to year,

but not much disclosed to why and how these figures were. With this information

we concluded that Stanley has an under-funded pension plan account, meaning

that the pension obligations were larger than the pension assets over the past few

years. However, even with this negative number there are smoothing effects that

occur in the financial statements that bring this number back to a positive. Within

the machine tools and accessories industry it was found that all of the companies

had under-funded pension plans, most with even larger negative numbers to

smooth out. In fact most corporations have a under-funded pension plan and it is

a controversial topic that has many regulations already being incorporated. In

addition, we concluded that Stanley uses a conservative accounting method and

has a great deal of disclosure when it comes to pension plans. Through this

analysis Stanley has shown to be assertive in their accounting policies through the

lower discount rate and increasing compensation rate while keeping in mind their

key success factors to successfully continue to be competitive within the industry.

Potential Accounting Flexibility

In accordance with GAAP, firms have some flexibility on how they prepare

their financial statements. This flexibility is granted to companies so they are able

to portray valuable information in a more informative manner. However, this

flexibility can also distort valuable information in a company’s financial statements,

making the company appear better than it actually is. Below are some the areas,

in which Stanley has flexibility.

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Warranty Liability

Management can alter the performance of a company by over and under

forecasting a firm’s warranty liabilities. Over-forecasting a firm’s warranty

liabilities increases the firm’s expenses, reducing the amount of net income

reported on the income statement. This strategy could by used to prevent new

entrants into the industry, discourage competitors from entering into a profitable

business segment or product line, and to reduce income tax payments. Under-

forecasting a firms warranty liabilities would have a reverse effect (decreasing

expenses and increasing net income). This strategy would strengthen a firm’s

performance image, and could be used to attract new capital through enhanced

investor perceptions. Both strategies have an affect on the company’s liabilities,

enabling the firm some control over its financial leverage. Although Stanley does

not appear to use this strategy, they have been able to lower their income tax by

over forecasting their warranty provisions in recent years.

Pension Plans

There are many areas in pension plans that have to be estimated to

determine the future value of the pension obligations and the pension assets that

are invested in to pay these obligations off. The determination of discount rates,

expected rate of return and the increase in compensation are some of the main

areas to identify when analyzing pension plans. When dealing with millions of

dollars in a corporation, subtle changes in the three for mentioned rates can

create a dramatic change in financial figures typically increases and decreases in

costs. Stanley and its competitors continually lowered their discount rates to be

between 5% and 6% in 2007. While these companies can determine their

accounting strategies there are many new regulations that are coming into effect

that can restrict the flexibility to use these factors in aggressive ways. For

example, in 2003 FASB revised the FAS disclosure requirements, and the FASB is

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creating a two phase project that will “focus on balance sheet recognition of

funded status” (http://blackactuaries.org) among other things. So it is getting

more difficult to hide underlying meaning. However, these companies still have

the right to choose what factors to use in a reasonable way. With and increase

(decrease) in discount rates to pension obligations the companies will decrease

(increase) their pension obligations. Also, a increase in discount rates to pension

costs would result in a decrease in service costs and a increase in interest costs,

resulting in an overall decrease in costs. The opposite is determined if discount

rates are decreased to pension cost “The discount rate is a little bit mixed because

it has opposite effects on the service and interest cost”. The same can be done

with the rate of compensation. While these are all ways to increase or decrease

obligations or costs there is not a whole lot of room for change without good

reason. New regulations such as FAS 123 have made it more difficult for

aggressive accounting. When aggressive accounting policies are used they try to

drive down costs and could raise red flags. Stanley and most of its competitors

use a conservative policy keeping the discount rates low, the rate of compensation

increase high and the expected rate of return close to the discount rate.

Conclusion

Stanley has some discretion over how they account for warranty provision,

altering the level of forecasted provisions could be used to make Stanley appear

more or less profitable than it actually is. Maybe in the recent past pension plans

were highly flexible because of the limited amount of disclosure required for why

they were selecting the rates they used to determine their figures. As regulations

increase and investors gain more knowledge disclosure is becoming more

important. While this is true there is still a good amount of flexibility in

determining the rates used to determine future obligations and costs, how the

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company pays off the pension obligation (equities, bonds), and the controversial

are of smoothing under-funded pension accounts. Stanley does a good job of

disclosing this information in their financial reports.

Actual Accounting Strategy

In accordance with GAAP, firms are given some discretion over the level of

disclosure they include in their financial statements. Management has the choice

of providing a high level of disclosure through conservative accounting, providing

a low level of disclosure through aggressive accounting, or providing adequate

disclosure that falls somewhere in between the two extremes. Through further

analysis of Stanley’s financial statements it would appear that Stanly has chosen

to use a conservative method of accounting.

The way in which Stanley accounts for warranty liabilities is very straight

forward. Stanley recognizes its warranty obligations based on historical service

and warranty claim experience, as well as their expected sales. Stanley, can only

estimate what the company believes its actual warranty payments will be, and as

a result the company is forced to estimate their warranty expenses. Once they

have received their actual warranty expenses for the year, they make the

appropriate corrections to their financial statements.

Actual accounting strategies involving pension plans include a conservative

accounting method along with a continued under funded pension fund. This fund

is under funded because of the low discount rate, high rate of compensation

increase, and keeping expected returns close to the discount rate. This under

funded account is a negative number, but this number does not show up on the

balance sheet. First, there is “smoothing” of the numbers with accounts such as

unrealized service costs. These accounts bring this negative number back into the

green. Also, with recent regulations companies are required to show their

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distribution of their pension assets which will offer even more disclosure. Making

companies show where they get the information to derive the discount rates and

other rates keeping them transparent and conservative.

Qualitative Analysis of Disclosure

The amount of information a company discloses in its financial statements

should include the best information a company can offer to the public, without

exposing company secrets to their competitors. High disclosure about a

company’s performance and direction can instill confidence in shareholders and

can help raise capital by attracting other investors.

Continuous Growth

Stanley offers a great deal of disclosure in its financial statements regarding

its current and future growth. Stanley especially provides high disclosure on its

acquisitions, as well as the performance of each of its business segments, clearly

identifying key profit drivers for the firm. This strategy may be risky in a highly

competitive industry, due to the threat of new entrants who recognize the profit

potential of some of the faster growing business segments. However, the firm

does not disclose the performance of individual product lines within these

segments. By not disclosing these individual product lines, Stanley has taken

some measures of protecting their more successful products from competitor

rivalry. Furthermore, having a relatively high level of disclosure pleases

shareholders, and could be helpful in financing future growth.

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Warranty liability

Stanley provides a fair amount of disclosure about on how they account for

warranty payments and warranty provisions. Stanley estimates what they

anticipate their warranty expenses to be, based on previous warranty expenses

incurred, and the expected level of sales. The sales from each individual business

segment are forecasted in order to accurately estimate warranty payments,

because of the large differences in warranties offered for each segment. Stanley

also anticipates higher warranty expenses during years where they introduce a

large amount of new products on the market. Disclosure of each business

segments also creates transparency of the types of warranties offered.

Pension Plans

Over the past five years Stanley has provided a great deal of disclosure

relating to the financial figures from year to year, but it takes some reading

between the lines to determine what it all means. With this information we

concluded that Stanley has an underfunded pension plan account, meaning that

the pension obligations were larger than the pension assets over the past few

years. However, even with this negative number there are smoothing effects that

occur in the financial statements that bring this number back to a positive. While

researching the competitor all of them did this exact same tactic, most with even

larger negative numbers to smooth out. In addition, we concluded that Stanley

uses a conservative accounting strategy. Stanley’s conservative accounting

strategy was derived from their continued decline in discount rates, there

increasing compensation rate and their expected return on plan assets staying

near the discount rate. We were able to determine all of this because of the very

transparent outline of pension plans that Stanley disclosed. They included the

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discount rate, compensation increase rate, and basically everything you would

need to know about Stanleys pension plans.

Conclusion

Stanley, as a whole, presents a good amount of disclosure in their financial

statements. In recent years Stanley has increased the level of disclosure in their

financial statements, primarily in regard to the performance of their individual

business segments. Although some of this disclosure may have been forced upon

them by stricter regulation passed by the Sarbanes-Oxley Act, the company’s

prosperous growth and performance may also have lead them to disclose more

information.

Quantitative Analysis of Disclosure

GAAP and other accounting standards have allowed managers to reflect the

company’s financial position through accounting flexibility. Because this flexibility

exists, it may give incentives to managers to be aggressive or conservative when

deciding accounting policies. Therefore, outside investors and analyst must search

for significant changes in numbers that may cast false light on the company. This

screening can be done by analyzing trends over the most recent five years of the

company.

Two types of diagnostics can be used when searching for discrepancies:

sales manipulation and expense manipulation. These diagnostics provide a better

view of the company’s revenues and expenses. Both diagnostics have specific sets

of ratios that pull items from three financial statements: Income Statement,

Balance Sheet, and the Statement of Cash Flows. Ratio items include things such

as: inventory, accounts receivable, cash from sales, assets, pension expense,

operating income, and several other line items. When looking at the ratios, an

analyst is looking for increase or decreases that cannot be explained in the

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company’s annual report or the company’s 10-K resulting in improper accounting

procedures. Any trend in increase or decrease of these ratios could signify a

possible distortion or misrepresentation.

Sales Manipulation Diagnostics

The sales manipulation diagnostics provide a look at sales performance and

give an outside investor the ability to detect any manipulations within the sales on

a year by year basis. The ratios attempt to see if sales are supported by the

denominator of each ratio. It is also important to calculate the same ratios using

the same methods to determine if any unusual numbers are in an industry wide

trend or if it is firm specific. The following ratios were taken from companies:

Black and Decker, Danaher, and Snap-on. Then these ratios are used to compare

the trends in ratios for Stanley Works.

Net Sales/Cash from Sales

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The chart shows the past five years of ratios for each company. The ratio

attempts to show the sales to the actual cash received from the sales. An all cash

business would have a 1:1 ratio. Since most companies are not based solely on

cash, there are some rang in ratios. Though this range exist, it is preferable that

the ratios remain close to 1 without increases; as this could be an indicator that

the company is lying about sales (ex.100/50=ratio of 2). As you can see, Stanley

Works compares very well with industry competitors and doesn’t show and

alarming differences in ratios. Stanley Works often has a ratio slightly larger than

one and can be explained by the company’s sales growth.

Some accounting “slop” can also be found when calculating these ratios.

Cash from sales is calculated by using the change in net accounts receivable.

When calculating these ratios, it was found that the change given on the

Statement of Cash Flows is different than when calculated using the Balance

Sheet; indicating some sloppiness on Stanley Works accounting procedure. Overall

this ratio provides nothing alarming and is fairly consistent with industry changes

and movements. It can be concluded that the Sales is supported by the cash from

sales meaning that over time cash is collected consistently with the sales made.

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Net Sales/Net Accounts Receivable

The ratio presented above attempts to see how well the company’s net

sales are supported by their receivables. Once again, the company and the

industry remain fairly consistent over the past five years with low ratios. Although

the industry and the company alone are growing, the ratio remains constant which

shows that the company is matching its assets (A/R) to its revenues. The ratios

provide nothing alarming and can be concluded that the company is not distorting

sales.

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Net Sales/Inventory

In this chart the ratios from net sales to inventory are plotted. These ratios

attempt to look at how well inventory is being turned over or used in relation to

the company’s sales. The ratios for Stanley Works indicate some backlog in

inventory for the company. This backlog seems to be consistent throughout the

industry as a whole. The company explains reasons for backlog in the company’s

10-K. It is explained by the short order cycles and “rapid” inventory turnover. “

Most customer place orders for immediate shipment and as a result, the company

produces primarily for inventory, rather than to fill specific orders” (SWK 10-K). A

more detailed look shows that the back log occurs in 2004 to 2006; because the

ratio is decreasing or downward sloping. This tells that fewer sales are being

made out of inventory. However, with the company’s explanation and the industry

similarities, there is nothing alarming about this ratio.

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Net Sales/Warranty Liabilities

Though the industry for tool manufacturers often and likely offer

warranties, Stanley Works is the only one among the companies being analyzed

that has given their warranty liabilities. The ratio provides a link between a

balance sheet liability and income statement item (revenue). This information can

be found in the letter to share holders. Looking at the graph, it can be seen that

the liabilities have not stayed in proportion with the sales growth. There is a sharp

decline from 2005 to 2006 meaning that the company is providing more warranty

liabilities faster than the growth in sales. This could mean that there has been

more product defects within the company; therefore selling more warranties.

Without an industry average it is hard to say if this is consistent. Overall, the set

of ratios are not alarming.

Conclusion

After examining all revenue related ratios, an analyst can draw an overall

conclusion about the quality of reporting within the sales. Looking at each ratio

that has an accompanying industry average, it can be concluded that Stanley

Works is not overstating or understating their net sales.

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Sales Manipulation Diagnostics SWK 2002 2003 2004 2005 2006Net Sales/Cash from Sales 1.01 0.99 1.03 1.01 1.04Net Sales/Net Accounts Receivable 4.76 5.70 5.63 5.81 5.72Net Sales/Unearned Revenue N/A N/A N/A N/A N/ANet Sales/Warranty Liabilities 392.00 340.47 202.52 209.25 70.75Net Sales/Inventory 5.47 6.87 7.36 7.13 6.71 BDK Net Sales/Cash from Sales 1.00 1.02 1.05 1.01 1.00Net Sales/Net Accounts Receivable 6.00 5.54 5.16 5.77 5.61Net Sales/Unearned Revenue N/A N/A N/A N/A N/ANet Sales/Warranty Liabilities N/A N/A N/A N/A N/ANet Sales/Inventory 5.91 6.31 5.50 6.22 6.06 SNA Net Sales/Cash from Sales 0.99 1.00 1.00 0.98 1.03Net Sales/Net Accounts Receivable 3.79 4.08 4.44 4.86 4.51Net Sales/Unearned Revenue N/A N/A N/A N/A N/ANet Sales/Warranty Liabilities N/A N/A N/A N/A N/ANet Sales/Inventory 5.70 6.36 7.04 8.34 7.81 DHR Net Sales/Cash from Sales 1.04 1.02 1.06 1.02 1.03Net Sales/Net Accounts Receivable 6.03 6.10 5.60 5.67 5.73Net Sales/Unearned Revenue N/A N/A N/A N/A N/ANet Sales/Warranty Liabilities N/A N/A N/A N/A N/ANet Sales/Inventory 9.43 9.87 9.79 9.68 9.55

* The chart shows the ratios calculated together in determining previous graphs and analysis *

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Expense Manipulation Diagnostics

Similar to the revenue diagnostics, the expense diagnostics observe if the

reported financial statements of a company are accurate or in other words

reliable. The following ratios can tell analysts how effective a company’s

management is with handling their expenses. Below are the expense diagnostics

for Stanley Works, Danaher, Black & Decker, and Snap-On.

Asset Turnover

Asset Turnover

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

2002 2003 2004 2005 2006Year

Stanley Black & Decker Snap-on Danaher

Looking at the last five years, the asset turnover ratio for Stanley Works

has held steady between .8 and 1.1. The one of the lowest points recently was

late in 2004 due to acquisitions of two large companies, thus it shows the difficulty

the business would have to instantly provide higher profits in relation to their new

assets. A red flag would have drawn if during these acquisitions Stanley

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maintained a constant ratio because their sales would have most likely been

overstated or in the other direction, their assets would have been understated.

More recently it can be seen that Stanley is slowly increases it their sales as of

2005 and on.

Observing the industry, all the companies follow a familiar trend in which

have consistently been around one (.98 avg.). The only outliers that could be

Danaher since they have a ratio smaller than the rest of the industry which is due

to their reinvestment into their own company assets in order maintain being a

large company.

Cash Flows from Operating Activities/Operating Income

CFFO/ OI

0.000.501.001.502.002.503.003.504.004.50

2002 2003 2004 2005 2006

YearStanley Black & Decker Snap-on Danaher

The CFFO/OI ratio reveals the amount of cash generated by a company’s

operating activities relative to its operating income. The industry follows along a

common ratio of around 1, meaning Stanley is pulling in almost the dollar for

dollar the same amount of cash from its operating activites as they are reporting

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in operating income for the year. Recently, it shows Sanley’s ratio increasing

meaniing they are having cash flow in from operating activies than their other

sectors of financing and investing.

Looking at Stanley Works in 2003, it is obvious there could be cause for a

“red flag” due to a significant change in the amount of operating income reported

on their income statement. This was due to restructuring plans that took place in

April of 2003, causing a drop from its Mac Tools retail channel(“MacDirect”), and

impairing its inventory and fixed assets related to the acquisition new distridution

facilities.

Cash Flows from Operating Activities/Net Operating Activities

CFFO/ NOA

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

2002 2003 2004 2005 2006Year

Stanley Black & Decker Snap-on Danaher

As for the CFFO/NOA ratio, the amount of cash generated by a company’s

operating activities is compared to the company’s fixed assets. As seen before the

industry tends to follow a familiar ratio, thus the Stanley’s and its industry are

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producing income from their fixed asssets of about a third of their total cash flows

from operations.

Danher once again could be picked as an oputlier here due to how much

larger of a company they are and amount of fixed assets they have and can

generate a much larger proportion of their cash from those fixed assets.

Pension Expense/SG&A

Pension Expense/ SG&A

-0.08

-0.06

-0.04

-0.02

0.00

0.02

0.04

0.06

2002 2003 2004 2005 2006

YearStanley Black & Decker Snap-on Danaher

Having pension benefits for retired employees requires firms to continue to

spend money on its former employees. This ratio is the relation between the

amount spent on pension plans and its selling, general, and administative costs;

low ratios are most desirable. Having low ratio indicates that Stanley and its

industry are limiting the amount they must spend on those who are no longer part

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of the company, therefore being able to reinvest those funds into their own

growing company.

At first glance, it looks like there is potential for a “red flag” here due to the

dramatic change in Stanley Works’ ratio for year 2002 to 2003. According Stanley

Works, “in 2001, the Company curtailed (reduced part of) the U.S. salaried and

non-union hourly plan with respect to eliminating the impact from future salary

increases on benefits” (Stanley Works 2002 10-K). By doing so, Stanley reduced

its 2002 expenses relative to its employee pension and benefit plans by $41

million. After the 2002 reduction, Stanley Works repositioned with the rest of its

industry competitors.

Other Employment Expenses/SG&A

Other Employment Expenses/ SG&A

0.0000

0.0020

0.0040

0.0060

0.0080

0.0100

0.0120

YearStanley Black & Decker Snap-on Danaher

As for most companies in this industry, they fall along a similar trend

because they all provide post-retirement benifts to their emplyees, such as health

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care and life insurance. It is unusual expect a decreases in these ratios, but it is

undestood that most likely this industry is seeing greater increases in their selling,

general, and administrative expenses. Since the other employment expenses are

fairly minute compared to other expenses, these ratios are easily changed and

could be a cause of accounting procedures to lower their company ratios to look

pleasing to outsiders.

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The following chart compares all of Stanley Works’ core expense

manipulation diagnostics to its current industry competitors’.

Expense Manipulation Diagnostics

Stanley 2002 2003 2004 2005 2006 Asset Turnover 0.9240 1.0255 1.0515 0.9267 1.0211CFFO/OI 1.2543 3.9314 1.1459 1.0114 1.1961CFFO/NOA 0.2225 0.3956 0.3064 0.2793 0.3072Total Accruals/Change in Sales -0.0259 -1.3787 -0.0924 -0.0142 -0.0982Pension Expense/SG&A -0.0774 0.0196 0.0157 0.0207 0.0218Other Employment 0.0102 0.0078 0.0050 0.0055 0.0065

Danaher Asset Turnover 0.7592 0.7683 0.8111 0.8714 0.7460CFFO/OI 1.0132 1.0184 0.9349 0.9519 1.0193CFFO/NOA 0.4970 0.5694 0.5844 0.6407 0.7182Total Accruals/Change in Sales -0.0020 -0.0217 0.0451 0.0556 -0.0182Pension Expense/SG&A 0.0118 -0.0106 0.0025 0.0073 0.0120Other Employment 0.0101 0.0113 0.0079 0.0024 0.0013

Snap-On Asset Turnover 1.0577 1.0443 1.0511 1.1762 0.9502CFFO/OI 1.1301 1.1792 1.0316 1.3161 1.2335CFFO/NOA 0.2916 0.2145 0.1774 0.2734 0.2536Total Accruals/Change in Sales -0.0122 -0.2168 -0.0259 1.1800 -0.2403Pension Expense/SG&A -0.0001 0.0315 0.0202 0.0240 0.0262Other Employment 0.0079 0.0010 0.0048 0.0063 0.0036

Black & Decker Asset Turnover 1.0391 1.0616 0.9761 1.1166 1.2286CFFO/OI 1.2272 1.3310 0.9860 0.7726 0.8410CFFO/NOA 0.3026 0.3673 0.3432 0.3608 0.3586Total Accruals/Change in Sales -0.0195 -0.7433 0.0094 0.1607 -1.5406Pension Expense/SG&A -0.0047 0.0117 0.0254 0.0355 0.0480Other Employment 0.0048 0.0100 0.0065 0.0051 0.0019

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Conclusion As for the core expense diagnostics in the machine, tools, and accessories

industry, the companies have generally exhibit very similar accounting practices.

Stanley Works may have a few indiscretions which outsiders might question, but

for the most part can be explained by their choice of accounting practices and

operations. As for Stanley Works, their accounting policies underline what they

want available, as far as company numbers, to the public and their competitors.

As a general rule, nothing seems as perfect as it may look on paper; therefore an

in-depth evaluation of a firm is essential in any assessment of financial activities.

Potential Red Flags

In examining the company’s quality of disclosure and the companies ratios

compared to that of its competitors, there have been no un-explained potential

red flags. Stanley Works has some questionable data regarding pension plans for

2002 and 2003 related to salaries and non-union pay. The company has disclosed

reasons for this as previously stated. Another questionable matter is inventory

blockage, which took place in years 2002-2005. The company has disclosed

reasons why this might occur for its own company, and that of the industry. In

accounting for goodwill, Stanley has not recorded impairment tests in recent

years. However, we did not consider this to be a red flag. Further explanation is

given in the fallowing section.

Overall, the company’s analysis for potential red flags is good. Other than

unprofessional accounting, such as the difference in changes of accounts

receivable shown on the statement of cash flows compared to calculating it from

the balance sheet, Stanley has provided explanations for every questionable

amount of data.

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Undo Accounting Distortions

As stated previously in the red flags section, there are a couple of minor

discrepancies on the annual report, but none that have an effect on the overall

outcome. While the transparency of the statements might be questioned, it

appears the numbers reported have no distortions. In 2003 the company wrote off

an allowance for doubtful accounts which totaled approximately $40 million.

However, the write off occurred because the company dropped the Mac Tools

channel of distribution. Although Stanley has not accounted for any impairment

tests for goodwill in recent years, this did not pose a serious concern. The

identification and measurement of goodwill and unamortized intangible asset

impairment involves the estimation of fair value (Stanley’s 2006 10-K). The

estimates of fair value of goodwill, indefinite-lived intangible assets and related

reporting units are based on the best information available at the date of

assessment, which primarily incorporate management assumptions about future

cash flows (Stanley’s 2006 10-K). Impairment of goodwill is caused by large

changes in expected profitability, cash flows, or significant changes in current

estimates of trade name usage (Stanley’s 2006 10-K). Since Stanley has not

reported any significant changes in these key areas, we did not view this as an

accounting distortion. After careful and thorough analysis of the companies

accounting methods, we did not find any serious distortion.

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Financial Analysis, Forecast Financials, and Cost of Capital Estimates

Financial Analysis Financial analysis is a valuable tool used by analyst to determine how the

company is performing in comparison to the companies goals, strategies, and how

it is stacking up to the competition. Ratio analysis takes certain items from the

balance sheet, income statement, or statement of cash flows and compares them

to another element in the financial statements to draw information about how the

company is performing. This information is useful in evaluating the liquidity,

profitability, and capital structure of the firm. Comparing these current ratios to

past ratios or ratios of competitors firms can begin to make forecasts of what is to

come. In essence this section shows where Stanley stands in relation to its

competitors.

Liquidity Analysis

Liquidity analysis is the use of the current ratio, quick asset ratio, accounts

receivable turnover, inventory turnover, Days supply of inventory, and working

capital turnover to determine the risk involved for a firms current liabilities. These

ratios are used to determine the firm’s ability to be able to pay back the current

liabilities (short-term obligations) that it owes. (text) The data collected from

these liquidity ratios is what lenders look at to determine what risk is involved in

giving short-term credit to a firm (www.netmba.com). These lenders of short-term

credit usually prefer a higher number in these ratios, meaning that the firm has

plenty of assets to pay off its current obligations. The ratios in the following

section will reveal Stanleys and its competitors “ability to turn short-term assets

into cash to cover debts”

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Current Ratio

Current Ratio

0

0.5

1

1.5

2

2.5

Year

Stanley 1.78 1.63 1.67 2.09 1.31

Snap On 1.91 1.99 1.77 2.12 1.63

Danaher 1.89 2.13 1.33 1.3 1.38

Black and Decker 1.51 1.68 1.63 1.49 1.52

Industry Avg. 1.77 1.86 1.6 1.75 1.46

2002 2003 2004 2005 2006

The Current Ratio is computed by dividing the Current Assets (cash, cash

equivalents, accounts receivables, inventory, and other assets that can be

converted into cash within one year) by the Current Liabilities (obligations due

within one year). The current ratio evaluates the firm’s ability to use its cash

received from current assets to pay off the current liabilities. Lenders generally

prefer firms with high current ratios, a current ratio of 2 or above means that the

firm is “generally considered to have good short-term financial strength”

(www.investorwords.com). While a current ratio of one or above means that the

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firm is able to pay off is current liabilities using its cash collected from current

assets.

Over the past five years Stanley has ranged from a current ratio of 1.31 to

2.09, meaning that Stanley can pay off its current liabilities fairly easy. The drop

from the 2005 current ratio of 2.09 to 1.31 in 2006 can be explained by an

increase in current maturities of long-term debt, which is long-term debt that is

maturing within the year. Over the past five years Stanley has produced a current

ratio that has stayed in line with the industry average, even with the decline in

2006 they were not that far off. So, the machine tools and accessories industry

seems to be able to turn their current assets into cash to pay off their current

obligations with a good cushion of current assets.

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Quick Asset Ratio

Quick Asset Ratio

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2

Year

Stanley 0.96 0.88 1.01 1.45 0.74

Snap On 1.04 1.13 1.03 1.89 0.91

Danaher 1.24 1.52 0.84 0.76 0.81

Black and Decker 0.36 0.23 0.29 0.43 0.13

Industry Avg. 0.9 0.94 0.79 1.13 0.65

2002 2003 2004 2005 2006

Quick asset ratio is current assets minus inventories (cash, short-term

investments, and accounts receivables) divided by current liabilities. Inventories

sometimes include items that are not easily liquidated, so quick asset ratio

subtracts the inventory out. Assuming that accounts receivables of the firm are

liquid, the quick asset ratio evaluates the firm’s ability to use its liquid assets to

pay off its current liabilities. Like the current ratio, a higher quick asset ratio

means that a firm has more available cash from liquid assets to pay of the current

obligations. Stanley’s quick asset ratio ranged from 1.45 to .74 in the past five years.

Similar to the drop in the current ratio from 2005 to 2006, the quick asset ratio

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also dropped in the same year. The explanation is that same, from 2005 to 2006

there was a major increase in current maturities of long-term debt. Other than

that dip Stanley’s quick asset ratio was right on or above the industry average,

and stayed pretty close to one. This means that if Stanley had to immediately pay

off its current obligations than they would probably be ok, because they are never

far off of one and they would probably be able to liquidate some of the inventory

to cover the difference.

Inventory Turnover

Inventory Turnover

0

1

2

3

4

5

6

7

Year

Stanley 3.64 4.52 4.65 4.57 4.27

Snap On 3.79 4.08 4.29 4.75 4.42

Danaher 5.75 5.88 5.68 5.5 5.32

Black and Decker 3.87 4.07 3.5 4.01 3.95

Industry Avg. 4.09 4.52 4.42 4.66 4.46

2002 2003 2004 2005 2006

Inventory turnover is calculated by dividing cost of goods sold by inventory.

“Inventory turnover reflects how frequently a company flushes inventory from its

system within a given financial reporting period” (www.vitalentusa.com). So, for a

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certain industry the ideal turnover would be reflected by balancing the carrying

costs with stockout costs incurred on that industry. A high inventory turnover

usually means that the company is working efficiently. However, a high turnover

could mean several different things that do not indicate an efficient company none

of which apply to Stanley or its direct competitors.

Stanley’s inventory turnover ranged from 3.64 to 4.65 which moved right

along with the industrial average. So, this means that over the past five years

Stanley average was to flush its inventory 4.15 times a year or about every 2.9

months, which is right on with the industry. One reason that Danaher’s inventory

turnover may be higher is that it is a conglomerate involved in many other areas

of business (Medical technologies, Industrial technologies, and Tools and

components) than the other competitors including Stanley that create a need for

different inventory levels.

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Days Supply of Inventory

Days Supply of Inventory

0

20

40

60

80

100

120

140

Year

Stanley 100.32 80.71 78.5 79.92 85.39

Snap On 117.99 101.02 94.55 80.22 84.88

Danaher 63.5 62.04 64.29 66.35 68.55

Black and Decker 94.41 89.75 104.39 91.03 92.3

Industry Avg. 94.05 83.38 85.43 79.38 82.78

2002 2003 2004 2005 2006

Days supply of inventory is calculated by dividing 365 by the inventory

turnover. This effectively gives you the number of days that the inventory is

sitting there before it is sold. The ideal would to have inventory sitting for zero

days, but once again this near impossible. The machine tools and accessories

industry average of days supply of inventory ranges from about 80 to 95 days

over the past five years. While Stanley has ranged from about 78 to 100 days

which is once again right on average with the industry. Again Danaher is a little

lower because of the increased inventory turnover caused by the fact that it is a

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conglomerate, effecting the amount of inventory needed on hand. Stanley’s 78 to

100 days of inventory sitting there is pretty good within the industry.

Receivables Turnover

Receivables Turnover

0

1

2

3

4

5

6

7

Year

Stanley 4.17 5.37 5.21 5.39 5.36

Snap On 3.79 4.08 4.29 4.75 4.42

Danaher 6.03 6.1 5.6 5.67 5.73

Black and Decker 6 5.54 5.16 5.77 5.61

Industry Avg. 5 5.27 5.06 5.39 5.28

2002 2003 2004 2005 2006

Receivables turnover is calculated by dividing sales by accounts receivables.

The receivable turnover ratio measures the degree that a company effectively

gives credit and collects on those debts. An increase in the ratio typically means

that the firm is collecting its receivables quicker and the opposite if there is a

decrease in the ratio. Depending on the industry a higher ratio typically means

that the firm is more effective in collecting the credit they lent out. Sometimes a

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high receivable turnover ratio can mean that the company does not accept credit

payments, working mainly or only in cash causing accounts receivables to be low.

Stanley’s receivables turnover ranged from 4.17 to 5.39, and the industry

average ranged from 5 to 5.39. These numbers basically compare the number of

dollars added to sales per one dollar of credit extended. So Stanley averaged

about 5.1 dollars of sales for every dollar of credit that was extended. From 2002

to 2003 Stanleys receivable turnover increased sharply and since then have stayed

pretty much constant. This sharp increase was caused by a slight decrease in

accounts receivables, with an increase in cash, and an increase in sales. Since

then sales have continued to grow while accounts receivables have grown with

them at a little slower rate. This is typical of the machine tools and accessories

industry, because these companies extend a fair amount of credit mainly to

industrial dealers that for the most part have a relationship built with the vendor

and are good on their debt.

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Working Capital Turnover

Working Capital Turnover

0

2

4

6

8

10

12

14

Year

Stanley 4.22 5.18 5.41 3.46 10.37

Snap On 4.23 3.96 4.49 4.07 5.74

Danaher 4.08 3.39 9.62 11.8 10.26

Black and Decker 5.8 5.03 4.76 5.95 6.98

Industry Avg. 4.58 4.39 6.07 6.32 8.34

2002 2003 2004 2005 2006

Working capital turnover is computed by dividing sales over working capital

(current assets minus current liabilities). The working capital turnover can be

used to evaluate how a company generates sales through effective use of its

working capital, and how the money to fund operations effects sales revenue from

these operations. So, a increasing working capital turnover is better because

more sales are received than the amount used to fund those sales.

Stanley’s working capital turnover ranged from 3.46 to 10.37 over the past

five years. This moved along with the industry average of becoming steadily more

efficient except for a dip in 2005 and a sharp increase in 2006. This can be

explained by an increase in sales and an increase in liabilities due to current long-

term maturities that were realized in 2006. So it could be determined through the

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increase in working capital turnover that Stanley has increased its efficiency in

working capital in 2006 to generate sales. As explained earlier Danaher may have

a higher working capital because it is a conglomerate including many different

industries needing a different amount of working capital.

Cash to Cash Cycle

The cash to cash to cash cycle is found by adding the A/R days to the

inventory days. When a business makes a sell by credit, cash is not necessarily

collected. This cycle shows how many days out of the year it takes to earn the

cash from the point the sell was made. It is a measure of how long the cash is

tied up in producing and selling a product. Based on this information, for every

dollar of sale, it takes Stanley works about 5 months to collect on it (150/30).

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Conclusion

Through the liquidity analysis using current ratio, quick ratio, inventory

turnover, days supply of inventory, receivables turnover, and working capital

turnover Stanley was determined to be a liquid company. For all the

aforementioned tools to determine liquidity Stanley was basically right on the

industry average for machine tools and accessories or a little ahead of it. It was

determined through the current ratio and quick ratio that there is a pretty good

size liquidity cushion in case of immediate payment of current obligations.

Analyzing the inventory turnover it was concluded that Stanley flushed its

inventory 4.15 times a year which was slightly ahead of the industry (with the

exception of Danaher which as mentioned before is a conglomerate). Stanleys

days supply of inventory was determined to be 78 to 100 days and was towards

the top of the industry. In conclusion, Stanley either outperformed or was

towards the top of the industry in all of the tools used to determine liquidity.

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Profitability Analysis

Profitability analysis is used to assess a company’s ability to earn profits.

Critical factors that affect a company’s profitability are operating efficiency, asset

productivity, the rate of return on assets, and the rate of return on equity. These

key factors are assessed using seven financial ratios: gross profit margin,

operating expense ratio, operating profit margin, net profit margin, asset turnover,

return on assets, and return on equity. The first four ratios measure the operating

efficiency of the firm, while the last three measure the revenue productivity of the

company’s resources. Profitability analysis provides and understanding of how

well a firm efficiently manages its resources, and minimizes its cost in order to

create a profit.

Gross Profit Margin:

-

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40

0.45

0.50

2002 2003 2004 2005 2006

SWKDHRSNABDKIndustry Avg.

Gross profit margin is an indicator of the degree to which a company’s

revenues exceed its product costs. Gross profit margin is calculated by

subtracting a company’s cost of goods sold from its revenue, which equals the

company’s gross profit, and dividing the gross profit from total revenue. The

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Gross profit margin is affected by how efficiently it manages its production

processes, as well as the price premium that a firm’s products or services receive

in the market. A high gross profit margin means that a company has more money

left over to pay debt and help fund future growth.

Over the past five years Stanley has maintained a consistent average gross

profit margin of 0.35, which falls just under the industry average. Although the

Gross profit margin falls below the industry average, it has grown slowly over the

past five years, particularly in 2003 and 2004. The majority of this growth can be

attributed to acquisitions purchased in 2002 and 2003, which significantly

increased Stanley’s economies of scale, and led to the expansion into the security

solutions segment, which carries higher profit margins.

Operating Profit Margin:

Operating profit margin describes the relationship between a firm’s operating

profit and net sales. A high operating profit margin indicates a high level of

efficiency in minimizing its operating costs. Conversely, firms with low operating

-0.02 0.04 0.06 0.08 0.10 0.12 0.14 0.16 0.18

2002 2003 2004 2005 2006

SWKDHRSNABDKIndustry Avg.

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profit margins are burdened with high operating costs due to inefficiencies. Over

the past four years Stanley has exceeded the industry average, showing a sharp

increase in 2003 and 2004. This increase in operating efficiency can be

contributed to the firm’s increased economies of scale through acquisitions, as

well as steady sales growth of 20.6 during 2004. Stanley’s ability to consistently

produce high operating profit margin shows how effective their management is at

controlling their operating expenses.

Net profit margin

-

0.02

0.04

0.06

0.08

0.10

0.12

0.14

2002 2003 2004 2005 2006

SWKDHRSNABDKIndustry Avg.

Net profit margin shows the relationship between net income and sales,

and is calculated be dividing a firm’s net income by its net sales. Net profit margin

calculates a firms return on sales (how much is earned out of each sales dollar),

and illustrates the profitability of the firm’s operating activities. It is also a good

way to measure the performance of firm’s operating management. A high net

profit margin indicates a high level of efficiency in controlling operating costs and

supports profitability. In contrast, a low net profit margin indicates poor efficiency

in controlling operating costs and reduces profitability. Stanley’s net profit margin

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has shown some variability over the past five years, mainly due to changes in the

cost of natural resources. However, Stanley has sustained an average margin

greater than the industry average, indicating a relatively high level of operating

efficiency.

Asset Turnover

-

0.20

0.40

0.60

0.80

1.00

1.20

1.40

2002 2003 2004 2005 2006

SWKDHRSNABDKIndustry Avg.

Asset turnover measures the revenue productivity of the resources

employed by the firm, and is calculated by dividing sales by total assets. “Asset

Turnover tells you how quickly the company is converting its physical asset base

into sales” (www.Reuters.com). A high asset turnover ratio indicates that a firm is

affectively using its resources to generate sales, while a low asset turnover ratio

indicates that a firm is not affectively using its resources to generate sales. A

lower ratio also indicates a high degree of capital intensity (www.Reuters.com).

Stanley’s asset turnover ratio has outperformed the industry average in the

majority of the past five years. Towards the end of 2004 through mid 2005, the

decline in asset turnover can be contributed to an increase in total assets through

acquisitions, and a decline in sales growth.

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Return on Assets

-

0.02

0.04

0.06

0.08

0.10

0.12

0.14

2002 2003 2004 2005 2006

SWKDHRSNABDKIndustry Avg.

Return on Assets is a measure of profitability that indicates how profitable a

company is in relation to its total assets. For public companies ROA can vary

substantially, and be highly dependant upon the performance of the industry

(www.investopedia.com). This profitability ratio is calculated by dividing net

income by total assets, and is expressed as a percentage. “This shows how much

return management has earned on all assets available to it, from all sources”

(www.Reuters.com). A high percentage means a company is successfully utilizing

its assets to generate profits. Stanley’s return on assets has been extremely

volatile over the past five years, and has decreased significantly over the past

three years. The large decline in recent years can be related to the purchase of

acquisitions, which have increased Stanley’s total assets by 62% since 2004.

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Return on Equity

-

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40

0.45

2002 2003 2004 2005 2006

SWKDHRSNABDKIndustry Avg.

Return on Equity measures the profitability of the stockholders interest in

total assets, and is calculated by dividing net income by owner’s equity. A firm’s

return on equity can be influenced by asset turnover, profit margins, and a firm’s

level of debt to equity. Stanley’s return on equity increased significantly in 2003

and 2004, as a result of increases sales as well as financing acquisitions using

debt. During the middle of 2004 and 2005, Stanley’s return on equity sharply

decreases due to declining sales, and an increase in owner’s equity resulting from

the issuance of 92 million shares of common stock in 2004 and in 2005 to finance

further growth.

Conclusion

After analyzing the profitability of Stanley and the profitability of the

industry as a whole, Stanley on average outperforms the industry. The company

showed excellent performance during 2003 and 2004, mainly due to increasing its

economies of scale through acquisitions and experiencing relatively high sales

growth. In the most recent years the company’s profitability has slowed down

closer to the industry average. This decline over the past few years has

somewhat weakened their profitability; however by consistently outperforming the

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industry average, Stanley continues to maintain a strong ability to efficiently

create profits.

Capital Structure Analysis The capital structure of a company is based on debt and equity. These are

the two sources of financing that a company can choose from in order to acquire

assets. Analysts are most concerned with three main ratios; debt to equity, times

interest earned, and debt service margin. In general the ratios used show the

amount of debt in relation to the owner’s equity, the ability to service the

principal, and the interest requirements on the company’s debt. The final

understanding of the ratios gives a generic idea of the company’s capital

structure.

Stanley Works Capital Structure Analysis

2002 2003 2004 2005 2006

Debt to Equity 1.46 1.79 1.31 1.45 1.54

Times Interest

Earned 8.87 8.00 10.68 11.00 7.26

Debt Service

Margin 1.92 2.94 3.62 2.13 1.37

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SWK Capital Structure

When looking at the table above, it is evident that Stanley’s capital

structure has remained relatively constant since 2002. This can be attributed to a

constant but equal increase in debt, equity, and cash flows.

Debt to Equity

The Debt to equity figures shown above are a measure the amount of debt

relative to the amount of equity in the company. According to investopedia.com,

“The debt to equity ratio is an indicator of the proportion of equity and debt the

company is using to finance its assets. A high debt to equity ratio generally

means a company has been aggressive in financing its growth with debt”. The

ratio is simply the total liabilities shown on the balance sheet divided by the

amount of total equity retained in the company. This ratio can be a key factor in

determining a company’s credit risk, by portraying the amount of reserves

available to cover the debt. Stanley’s debt to equity has stayed under the industry

average every year from 2002 to 2006. They have maintained a low five year

average of 1.51, which is considered very stable. This low number also means

that Stanley has available funds to repay any obligations, which in turn indicates a

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low credit risk. Their use of debt is very similar to that of the industries, which

could show that on average the industry is not very aggressive in their use of debt

financing.

Times Interest Earned

Times interest earned is a ratio that shows the amount of operating income

that can be used to cover the amount of interest expenses. The ratio starts by

using net income before interest and taxes (NIBIT), which is found by adding

interest expense and income taxes back to net income. The NIBIT is then divided

by the interest expense. Stanley’s times interest earned fluctuated from a low of

7.26 in 2006, to a high of 11 in 2005. The fluctuations are due to the company’s

net income varying while the interest expense grew at a consistent rate from 2002

to 2006. With an average times interest earned in the five year period of 9.16,

Stanley has continued to maintain adequate cash flows to cover their interest

expense. However the industry’s five year average is higher, at 12.02. Stanley

may need to increase its operating cash flows to a level that would put their times

Times Interest Earned

-

5.00

10.00

15.00

20.00

25.00

30.00

2002 2003 2004 2005 2006

Year

Rat

io

SWK

DHR

SNA

BDK

Industry Avg.

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interest earned ratio at a more comparable level with that of the industry.

Although Stanley might fall just short of the industry average, their direction is

relatively the same.

Debt Service Margin

-

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

2002 2003 2004 2005 2006

Year

Ratio

SWKDHRSNABDKIndustry Avg.

Debt Service Margin

The debt service margin ratio is used to visualize the ability the company

has to cover the current maturities of long term debt with cash provided by

operations. This ratio is computed by dividing the cash provided by operating

activities by the installment due on long term debt. Stanley’s ratio increased from

2002 to 2004, and then proceeded to decrease at a similar rate to 2006. Stanley’s

ratio average over this five year period has been 2.396, while the industry’s five

year average has been 2.078. The graph above shows that even though Stanley’s

debt service margin has fluctuated over the past five years, the industry average

has done the same as well as that of two of the competitors.

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Growth Rates: IGR and SGR

Without a doubt, the most important and common source for determining the

future profitability of a company is by analyzing the growth rates in revenue and

earnings. The growth rates are a terrific measuring stick for firms because “firms

that fail to meet growth forecasts frequently see their stock values plummet”

(www.zweigwhite.com). Several elements are needed to calculate the Internal and

Sustainable growth rates including return on assets, dividend payout ratio, and the

debt to equity ratio. You find IGR by taking ROA and multiplying it by 1 minus the

dividend payout ratio, and SGR by taking IGR and multiplying it by 1 plus the debt

to equity ratio.

(IGR) Internal Growth Rate

The Internal Growth Rate is measured as the highest rate of growth a

company can achieve without increasing their earnings. Stanley Works’ Internal

Growth Rate is relatively higher than its competitors with an average rate of 49

percent over the last five years. Black and Decker Corporation has an IGR

extremely lower than the industry’s competitors and has been identified as an

outlier because the company’s rates distort the industry average which is why it

was not included in the calculations. Having such a low IGR reveals they are

financing future endeavors with less internally generated cash, and instead,

outside debt. Snap-On Inc. and Stanley experienced almost identical internal

growth rates, showing investors that they are using quite a bit more internal funds

rather than borrowed money to fund future projects.

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Internal Growth Rate

2002 2003 2004 2005 2006

SWK 0.51

0.50

0.51

0.47

0.48

DHR 0.36

0.39

0.41

0.47

0.42

SNA 0.53

0.51

0.48

0.47

0.44

Industry Avg. 0.47

0.47

0.47

0.47

0.45

(SGR) Sustainable Growth Rate

A firm’s Sustainable Growth Rate is the maximum growth rate a company

can sustain without having to increase financial leverage. Once again Black and

Decker an outlier and was not included with the industry averages due to a

sustainable growth rate that greatly exceeds that of its competition. Stanley

Works shows some inconsistencies from year to year, bouncing around between 3

and 22 percent, while Danaher had comparable figures. Snap-On Inc. had

noticeably smaller sustainable growth rates over the same five year period. By

increasing ones financial leverage with debt financing a company simultaneously

reduces their future profitability.

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Sustainable Growth Rate

2002 2003 2004 2005 2006

SWK 0.10 0.03

0.22

0.12

0.12

DHR 0.10

0.15

0.17

0.18

0.17

SNA 0.06 0.02 0.02 0.03 0.04

Industry Avg. 0.09

0.07

0.14

0.11

0.11

Financial Statement Forecasting

To begin the process of forecasting Stanley Works, there was a strenuous

and in depth evaluation of several past annual 10-k reports. In these reports,

three financial statements are present: income statement, balance sheet, and the

statement of cash flows. By understanding how, why, and what happened in each

financial statement year by year a more reliable and accurate forecast can be

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developed. In theses forecasts, it is much easier to see what Stanley’s key

“drivers” may be, reasons for expected shifts in company sectors, and most

importantly, what should be the expected growth in expenses, assets, earnings,

etc. Using the past 5 years of Stanley’s annual 10-ks, it was possible to forecast

Stanley’s overall performance by using a comprehensive approach. A

comprehensive analysis will provide many links between the three financial

statements instead of just evaluating each one individually.

Income Statement Analysis

As said before, a common sized Income statement was created for all the

line items by comparing them to the respective year net sales. Afterwards,

averages were made for each line item over the course of several years and

ignoring useless rates that didn’t follow any foreseeable outcomes. Most of the

useless information pertained to past year performances (mainly 2001, ’02, ’03)

that showed no relation to the more current years. By doing so, assumed

averages were made from Stanley Works’ income statement with some

comparison to its industry numbers as well. Finally, it was possible to present a

10 year forecast of Stanley’s income statement.

In Stanley’s instance, every item in their income statement was forecasted,

but it can be understood that several items may be irrelevant even though they

presented a similar averages each year. Having multiple acquisitions and several

new product lines in the last several years led to an assumption of a fairly high

growth rate for Stanley’s sales and their past sales performances displayed

progressive increases. For that matter, a 14% growth rate in sales was assumed.

This felt reasonable considering Stanley had a growth rate of at least 20% in two

of its past three years and the industry average was 11.74%; which Stanley had

the second highest growth rate. On the other hand, according to investors, the

mean growth rate for the next 5 years should be 11% (stanleyworks.com). There

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could be a number of reasons for this, but mainly, holding a growth of over 15%

into the future would be outstanding for any companies that exist.

As for the rest of Stanley’s forecasted line items, each one seemed to be

slightly below or above the industry averages, meaning Stanley Works is following

its industry rates, but not shying far away from them. According to past years,

Stanley has a growth rate average of 15.94% compared to its industry’s average

rate of 11.74%. Having higher growth than its industry it could be expected to

see a much slower growth rate in the future. For example, to retain or even grow

in sales is complex and expensive process by which the company needs to seek

out new customers and channels that have not been tapped yet before their

competitors do. Overall, to continue with this growth it is expected that all other

items in the financial statement must grow at greater rates as well.

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Balance Sheet Analysis

Like the income statement analysis, a common sized balance sheet is

needed first in order to evaluate and forecast Stanley Works’ financial position in

the future. To do this, all items in the balance sheet were compared to its total

assets as well as the forecasted items in the income statement, like the growth in

net sales. Once the total assets were forecasted out, it allowed for particular

items in the balance to be examined for credibility in their forecasts by comparing

them to present ratios found for Stanley Works; the main ratios used were: asset

turnover, inventory turnover, accounts receivable turnover, and the current ratio.

Beginning with an average asset growth of the last three years and comparing it

to the forecasted growth in net sales it is possible to judge what would be the

expected asset growth. Analyzing this data, one thing to consider was that

Stanley had been involved in at least three main acquisitions in the past several

years, therefore causing their total assets to grow much larger. Seeing this, it

seemed ideal to choose a smaller growth rate since it would be fairly difficult to

continue with such a substantial growth in assets each year. Now, by comparing

both the income state and balance sheet growths with the asset turnover ratio

calculated before of 1.02 for 2006. It was determined that Stanley Corporation

should assume their total assets would grow by 13% which was lower than their

average because the forecasted growth in net sales had been 14%, therefore

keeping the company’s asset turnover ratio consistent with the its future forecasts.

Finding an accurate relationship between the income statement forecasts

and the asset forecasts in balance sheet allowed for the forecasted values in

inventories and accounts receivables to be checked for their credibility with their

corresponding liquidity ratios (A/R and Inventory turnover). For instance, since

asset turnover related the sales and total assets together it would accurate for the

inventory turnover ratio to coincide with the inventory forecasts and cost of goods

sold. Looking at the assumed rates forecasted of 64% of sale for the cost of

goods sold and 14% of assets for the inventory, the a forecasted inventory

turnover ratio of 4.57 would be considered fairly accurate compared to the

current ratio found of 4.27. As for the receivables turnover ratio, the sales

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forecasted and the current ratio of the company of 5.36 can be applied to give

more accurate forecasting in how much inventory could grow. Checking the

assumed growth in both, the range from one year out to the tenth year out was

from 5.47 to 5.8.

With regards to the liabilities section of the balance sheet, it is a fact that

assets should equal the sum of the total shareowners equity and total liabilities.

That was an easy very accurate check when evaluating those forecasted values,

but was even more convincing that these values were how they related to both

the current ratio and industry average. The average current ratio over the past

five years was found to be about 1.69 and the forecasted values consistently

produced ratios from 1.72 to 1.69. Furthermore, industry averages were found to

be just about identical to the Stanley’s averages for its equity and liabilities

sections (40%and 59% respectively).

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Cash Flow Analysis

Once again, the statement of cash flows was common sized comparing the

entire statement to net income from the income statement. From there, attempts

were made to identify any trends and there were none it seemed except for the

CFFO/Sales. By averaging the past three years of CFFO/Sales, an 11.5% was

used to forecast the cash flows from operating activities. Even though there

seemed to be no relationship with net earnings, it was still forecasted using the

average of the last two years. Even from there, none of the ratios seem to have

any reasoning for their numbers. This could have been true for many reasons;

either several items were accounted for in the income statement or other items

were not accounted for.

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Conclusion

In conclusion, having used the common sized financial statements, relative

ratios, and making educated assumptions to forecast one can be almost

completely confident that Stanley Works’ will continue to constantly grow not only

in the industry, but as a prospering world wide corporation.

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Analysis of Valuations This section provides sets of ratios that can be used in determining a more

accurate share price based on a specific industry average. In this case, the

average is calculated using direct competitors. A set of ratios called the “method

of comparables” are a fast way at looking to see if the company is overvalued,

undervalued, or fairly valued. The comparables used are: trailing and forward P/E,

P.E.G., P/B, P/EBITDA, P/FCF, D/P, and EV/EBITDA. Intrinsic Valuations are a

more detailed and somewhat more accurate way in determining what the shares

are actually worth. These valuations use the following models: discounted

dividends, free cash flows, residual income, long-run residual income perpetuity,

and abnormal earnings growth.

Method of Comparables

Ratio Price Forward P/E $61.41Trailing P/E $58.34P/B $74.49EV/EBITDA $69.73D/P $79.15P.E.G. $58.41P/FCF $58.11P/EBITDA $68.95

Nov 1, 2007 Actual PPS is $57.55

The chart above is the end results of screening ratios. They are based on

Stanley Works competitors and are the result of per share data compared to the

company’s most recent 10-k and annual reports. All ratios show that the company

is currently undervalued as of November 1, 2007. The Comparable ratios can be

broken down as follows.

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Forward Price to Earnings

PPS EPS P/E Industry Average

SWK Share Price

SWK 57.55 4.18 13.77 14.69 61.41 BDK 82.08 6.84 12.00 SNA 46.77 3.54 13.21 DHR 82.06 4.35 18.86

This method is calculated by using a forecasted earning on a per share

basis and a November 1, 2007 share price for Stanley Works. The competitor’s

data is more recent date and forecasts taken from yahoo. Finance for the

simplicity of the model. The end result comes from multiplying the industry

average based on P/E (not including SWK) by Stanley Works Nov. 1 share price.

This model states that the company is currently undervalued. Since earnings are

expected to grow, the companies forward P/E is lower than the current which

drives up the models calculated share price. If you were to throw the Danaher

Corporation out as an outlier however, the share price would be considered to be

fairly valued at $52.69.

Trailing Price to Earnings

PPS EPS P/E Industry Average

SWK Share Price

SWK 57.55 3.54 16.26 16.48 58.34 BDK 82.08 6.32 12.99 SNA 46.77 2.75 17.01 DHR 82.06 4.22 19.45

This method is like the previous method except it uses earnings (put into a

per share basis) from 2006 rather than forecasted earnings. The PPS’s are still the

same as previous and the competitors data is used from yahoo’s finance section.

Because there is no forecasted data this P/E method is more accurate. The share

price produced in this method shows that Stanley Works is considered to be fairly

valued.

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Price to Book

PPS BPS P/B Industry Average

SWK Share Price

SWK 57.55 21.74 2.65 3.43 74.49 BDK 82.08 16.89 4.86 SNA 46.77 20.72 2.26 DHR 82.06 25.95 3.16

The price to book method uses the same Nov.1 share price and the book

value of equity as stated on the most recent 10-k. By multiplying the industry

average (based on P/B) by SWK’s price per share will give a price of $74.49. This

Price tells you that the company is currently undervalued. A lower P/B ratio alone

could mean that the company is undervalued. This holds true with SWK being at

2.65. The P/B also tells you whether you would be paying too much if the

company went bankrupt.

Dividend Yield

PPS DPS D/P Industry Average

SWK Share Price

SWK 57.55 1.17 0.020 0.015 79.15 BDK 82.08 1.63 0.020 SNA 46.77 1.10 0.024 DHR 82.06 0.08 0.001

This method divides the Nov.1 price by the dividends per share. DPS was

calculated by dividing the dividends paid out by the amount of shares outstanding

on the most recent 10-k’s. Essentially it is the PPS divided by any return on

investment for a stock. When dividing the industry average (based on D/P) into

SWK’s DPS, the price produced is $79.15. This price shows that the company is

undervalued. However, if you remove Danaher as an outlier, the price falls to $54;

meaning the company is fairly valued.

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Enterprise Value to EBITDA

EV (billions)

EBITDA (millions) EV/EBITDA

Industry Average

SWK Share Price

SWK 3.76 779.9 4.82 10.18 69.73BDK 6.5 821.6 7.91 SNA 3.18 377.5 8.42 DHR 28.11 1980 14.20

This method uses the companies enterprise values. Enterprise value is like

a market cap and can be thought of as a “take over price” (investopedia.com).

Enterprise value is =MVE+ Value of Liabilities – (Cash and equivalents) and is a

representation of the firms value. EV for competitors was taken from

Yahoo.Finance. This method also uses EBITDA. This is a non GAAP measure and

has a possibility of distortion. EBITDA was taken from the company’s most recent

10-K. This method is done by multiplying the industry average (based on

EV/EBITDA) by the Stanley Works EBITDA, then subtracting back the liabilities,

cash, and equivalents as stated on the most recent balance sheet. The model

produces a price of $69.73 which shows that the company is undervalued.

However, to remain constant, removing DHR will give a price of $51. This price

says that the company is fairly valued or slightly overvalued.

Price Earnings Growth

PPS EPS PEG Industry Avg. SWK Share Price

SWK 57.55 3.54 2.17 2.20 58.41 BDK 82.08 6.32 1.73 SNA 46.77 2.75 2.27 DHR 82.06 4.22 2.59

The price earnings growth model is calculated by taking the price earnings

ratio and dividing it by the estimated annual earnings per share growth. This ratio

is an excellent indicator of a stocks potential value, and is often preferred over the

P/E ratio because it accounts for growth (www.investopedia.com). In order to

derive Stanley’s Share price from this ratio, we took the average PEG ratios of

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Stanley’s competitors and multiplied that number by Stanley’s estimated earnings

growth rate of 7.5 percent. We multiplied that number by Stanley’s earnings per

share, which gave us a share price of $58.41. By comparing Stanley’s current

share price of 57.55 with our derived share price of 58.41, we see that Stanley is

slightly undervalued.

Price to EBITDA

PPS EBITDA (In Billions) P/EBITDA

Industry Avg.

SWK Share Price

SWK 57.55 0.7799 73.79 88.41 68.95 BDK 82.08 0.8216 99.9 SNA 46.77 0.3775 123.89 DHR 82.06 1.98 41.44

This method compares a firm’s share price with a firm’s earnings before

interest, taxes, depreciation, and amortization. In this model we used the price to

EBITDA ratio to derive Stanley’s share price. For Stanley, we used the share price

reported November 1, 2007, and the EBITDA reported on their 2006 10-K. For

Stanley’s competitors we used the current share price and EBITDA listed on yahoo

finance. In order to work with easier numbers for this calculation, we expressed

EBITDA in billions rather than millions of dollars. Once we calculated the price to

EBITDA ratio for each company, we than derived an industry average by taking

the sum of Stanley’s competitors P/EBITDA ratio and divided it by three. This

gave us an industry average of 88.41. We multiplied that number by Stanley’s

EBITDA, which gave us a share price of $68.95. By comparing this price with

Stanley’s current share price of 57.55, we see that Stanley is undervalued.

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Price to Free Cash Flows

PPS FCF per share P/(FCF per share) Industry Avg.

SWK Share Price

SWK 57.55 0.745 77.2 78.01 58.11BDK 82.08 1.37 59.9 SNA 46.77 0.853 54.8 DHR 82.06 0.688 119.3

This method compares a firm’s market price to its level of annual free cash

flow, and is calculated by taking the price per share and dividing it by the firm’s

free cash flows. A firm’s free cash flows are calculated by adding their operating

cash flows and investing cash flows. Once we calculated Stanley’s P/FCF and the

P/FCF of Stanley’s competitors, we than derived an industry average using the

P/FCF of Stanley’s competitors. We than multiplied the industry average P/FCF by

Stanley’s FCF, and derived a share price of $58.11. By comparing our derived

share price of $58.11 with Stanley’s current share price of $57.55, we see that

Stanley is once again undervalued.

Conclusion

In observing all of the previous valuations, it can be said that Stanley

Works is an undervalued company. In considering a possible outlier such as the

Danaher Corporation, the observation produces a somewhat fairly valued

company. There is also the possibility that throwing out Danaher makes a less

weighted industry average giving less reliable PPS. Though these are good

screening models, there are chances that they are inaccurate do to the

competitor’s different strategies and markets. Overall, based on just the methods

of comparables, the company is fairly valued to slightly undervalued.

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Cost of Equity The cost of equity, demonstrated as Ke in the following pages, is calculated

as an expectation for return on stock that a market or equity holder would require

for bearing that certain risk. The method used to find the cost of equity was the

CAPM model. In order to complete this model several regressions were ran to find

a more accurate beta. The risk free rates that were used came from the St. Louis

Federal Reserve Bank’s website. There we used the Treasury’s constant maturity

rates for 3 months, 1 year, 2 years, 5 years, 7 years and 10 years in order to

determine whether Stanley Work’s is a better short term versus long term

investment. A 6.8% was used for a market risk premium. We used this percentage

because it is a long run average return from about 1926- 2005 for the Standard

and Poor’s 500 index. Though some may argue that the premium is actually lower

due to a variety of changes in the U.S. economy, we continued to stick with the

high premium because of its long term basis and since Stanley Works is included

in today’s S&P 500 index.

We ran five regressions for each point in order to test the stability of Beta

and to find the highest R2. After running the regressions for 72, 60, 48, 36, and

24 months for each point on the yield curve (3 mth, 1, 2, 5, 7, & 10 yr), it was

decided that the 3 month point gave us the most accurate beta. This was

determined because it gave the highest adjusted R2 or explanatory power of

39.3% which led to the use of a 1.399 beta. An R2 is a measure that “represents

the percentage of a security’s movement that can be explained by movements in a

benchmark index” (investopedia.com). The benchmark index used is the S&P 500.

Since the highest R squared is found in the 3 month point, it can be said that

Stanley Works is a better short term investment company. The beta that was used

was a 1.399 and is very similar to the published beta of 1.4 (finance.yahoo.com).

After gathering all necessary information, we plugged it into the CAPM model:

.04+1.4(.068) which gave a cost of equity= Ke 13.52%.

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Regression Analysis

3 Month Rate 72 month

60 month

48 month

36 month

24 month

Rf 4.00% 4.00% 4.00% 4.00% 4.00% Adj. R2 0.259 0.351 0.357 0.393 0.341 Beta 0.999 1.557 1.403 1.399 1.475 Ke 10.79% 14.59% 13.54% 13.51% 14.03%

1 Year Rate 72 month

60 month

48 month

36 month

24 month

Rf 4.14% 4.14% 4.14% 4.14% 4.14% Adj. R2 0.248 0.351 0.357 0.392 0.339 Beta 1 1.56 1.405 1.399 1.472 Ke 10.90% 14.71% 13.65% 13.61% 14.11%

2 Year Rate 72 month

60 month

48 month

36 month

24 month

Rf 4.01% 4.01% 4.01% 4.01% 4.01% Adj. R2 0.249 0.351 0.359 0.3908 0.337 Beta 1.002 1.563 1.411 1.401 1.472 Ke 10.81% 14.63% 13.59% 13.53% 14.01%

5 Year Rate 72 month

60 month

48 month

36 month

24 month

Rf 4.20% 4.20% 4.20% 4.20% 4.20% Adj. R2 0.249 0.352 0.363 0.3902 0.336 Beta 1.01 1.564 1.42 1.399 1.471 Ke 11.07% 14.84% 13.86% 13.71% 14.20%

7 Year Rate 72 month

60 month

48 month

36 month

24 month

Rf 4.33% 4.33% 4.33% 4.33% 4.33% Adj. R2 0.249 0.352 0.365 0.39009 0.336 Beta 1.01 1.564 1.424 1.399 1.47 Ke 11.17% 14.94% 13.98% 13.81% 14.30%

10 Year Rate 72 month

60 month

48 month

36 month

24 month

Rf 4.52% 4.52% 4.52% 4.52% 4.52% Adj. R2 0.249 0.249 0.366 0.39 0.336 Beta 1.01 1.564 1.427 1.399 1.469 Ke 11.37% 15.14% 14.20% 14.01% 14.49%

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Conclusion

The previous summary of regressions proves that beta is not stable over

time, contrary to the CAPM model theory. However, on a 36 month history, beta

proves stable over the 6 plots on the yield curve. This shows that Stanley works is

a better short term investment because the highest R2 is obtained in a 36 month

plot over a 3 month rate.

The graph above is the cost of equity plotted on seven points of the yield curve.

The curve proves that beta is not stable and time independent over periods of

time.

Cost of Debt

Stanley Works average cost of debt, Kd on a before tax basis is 4.77%. This

average was calculated by first assigning an interest rate with every liability listed

on Stanley Work’s balance sheet. Most interest rates were taken as stated in the

company’s annual report. Short term borrowings had an average interest rate of

4.2%- 4.7%; we took a more conservative approach and applied the 4.7% as the

interest rate to short term borrowings. On the other hand we applied the 4.2%

average to the current maturities of long-term debt. For the accounts payable we

used the company’s notes payable in 2007 interest rate of 4.5%. For long-term

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debt, we used the company’s interest rate for long-term notes payable which is

stated as 4.9%. In order to get an interest rate for deferred taxes we used the 10

year treasury constant maturity rate as found on the St. Louis Fed. Reserve

website. We used this 4.5% interest rate because it is the government who

collects on these deferred taxes. On the final liability “other liabilities,” the

company had “other payables” interest rates from 0-7.8%. We chose to go with a

6% interest rate on the other liabilities. The next step was to take find the percent

weight of each liability. This is done by dividing each liability by the total liabilities.

After finding each individual weight, we then multiplied the weight by its individual

interest rate and took the sum of these numbers as follows:

Liabilities and Shareowners Equity 2002 2003 2004 2005 2006 Interest Rates Weight Kd Current Liabilities Short-term borrowings 140.10 47.10 148.10 89.70 4.70% 3.76% 0.18% Current maturities of long-term debt 8.60 157.70 55.40 22.10 230.30 4.20% 9.66% 0.41% Accounts payable 238.90 222.20 297.90 327.70 445.20 4.50% 18.68% 0.84% Accrued expenses 266.50 314.30 417.00 374.30 485.90 4.20% 20.39% 0.86% Liabilities held for sale 27.90 62.50 3.70 3.10 Total Current Liabilities 682.00 756.70 821.10 875.30 1251.10 Long-Term Debt 563.20 513.60 481.80 895.30 679.20 4.90% 28.50% 1.40% Deferred Taxes 81.60 72.30 83.40 67.20 4.50% 2.82% 0.13%

Other Liabilities 189.20 202.80 238.70 246.20 385.90 6.00% 16.19% 0.97%

Total Liabilities 1434.40 1554.70 1613.90 2100.20 2383.40 AVG Kd 4.77%

The average cost of debt will be needed in calculating Stanley works weighted

average cost of capital.

Cost of Capital (WACC)

After getting the cost of equity and the cost of debt it is possible to find the

weighted average cost of capital. The effective tax rate used to get a before tax

basis was about 21%. This tax rate was clearly stated in the company’s annual

report and in the company’s 10-k. This tax rate is lower than usual because of the

company’s European based acquisition. In the formula we used the book value of

liabilities and the market value of equity as of close Dec. 31, 2006. In plugging in

the numbers the WACCBT came out to be 10.31% this formula included multiplying

107 | P a g e

by 1- tax rate. On an after tax basis WACCAT came out to be 9.95%. In valuing the

firm it is important to use a before tax basis since we have already accounted for

tax in our free cash flows. The following cells shows the data used in calculating

both WACC (BT) and (AT).

PPS 50.29WACC AT= 9.95%

# Shares 81,841,627WACC BT= 10.31%

Ve 4115.8 Vd 2383.4 Kd 4.77% Ke 13.52% Tax rate 20.60% Value of firm 6499.2

108 | P a g e

Intrinsic Valuations

Intrinsic valuations provide a more detailed and better look versus the

method of comparables. The models attempt to look at different sections of the

firm. The models also provide a sensitivity analysis which test to see if the firm is

overvalued or undervalued using different variations of Ke and growth.

Discounted Dividends

The dividends discount model is an easy valuation to run, but can

misconstrue the real fair value of a firm. This is the only model that uses

dividends on a per share basis each year to forecast an estimated firm share price.

Once forecasted, the dividends are discounted back to year 2006 and then grown

to November 1, 2007. From here, one will most likely get a very untrusting view

of the firm because dividends give no real view of how well the firm is doing or

what it may do in the future. In other words, the firm may be doing very well or

very poorly, yet still pay out the same dividends. The following is the dividends

discount model for Stanley Works.

Sensitivity Analysis

Growth Rates 0 0.01 0.02 0.03 0.04

Ke 0.11 $88.36 $92.55 $97.68 $104.08 $112.31 Under-valued > 66.18 0.12 $79.86 $83.08 $86.94 $91.66 $97.55 Fairly Valued with in 15% 0.135 $69.59 $71.82 $74.43 $77.55 $81.31 Overvalued < $48.92 0.15 $61.49 $63.08 $64.91 $67.05 $69.57 0.16 $56.99 $58.29 $59.74 $61.43 $63.41

Looking at this model, Stanley Works looks to be fairly undervalued. The

model gives a per share value of the firm discounted back to the present and then

a time consistent value is calculated because the firms fiscal year end is December

31. According to the model, Stanley share price is calculated to be $69.59 while its

current market share price is $57.55 making it slightly undervalued. This may be

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due to how a firm’s dividends have no consistency with how a firm’s share price is

constantly fluctuating. Meaning it shows no variation in share price over years to

come and is a very unreasonable way to evaluate a company’s value, especially

considering many companies don’t even payout dividends.

Free Cash Flows

Using the discounted free cash flow model is a good way to more or less

understand the relationship between the weighted average cost of capital and

growth rates of a firm. On the other hand it can be look at as a unreliable model

to value a firm with due how much weight of cash flows in Stanley Works actually

contribute to its firm’s total value. In this firm 52% o the forecasted present value

of the continuing terminal value of cash flows can account for Stanley’s firm value,

leaving about 48% of the firm’s value to be relied upon its assumed growth rates

in the company.

Sensitivity Analysis

Growth Rates 0 0.01 0.03 0.05 0.07 0.07 $135.91 $153.80 $216.43 $404.32 N/A 0.08 $111.73 $124.05 $163.49 $255.50 $715.58 Under-valued > 66.18 WACC BT 0.0995 $78.86 $85.44 $104.27 $138.32 $218.54 Fairly Valued with in 15%

0.1 $78.19 $84.67 $103.19 $136.52 $214.29 Overvalued < $48.92 0.11 $66.12 $71.00 $84.42 $106.79 $151.52

After running the model and using the sum of the forecasted annual free

cash flows for the taken back ten years, plus the present value of the perpetuity,

Stanley’s firm value could be calculated to be $8,607 million. Finally, using the

market value equity for Stanley (value of the firm - book value of liabilities) and

dividing it by the number of outstanding shares (82.2 million), an estimated price

per share was found. Last, to made time consistent with Stanley’s fiscal year end

on December 31, the price per share was multiplied by the cost of capital raised

110 | P a g e

the ten months divided by twelve. The result was a time consistent price per

share of $78.66.

Like the dividends model run, with a zero growth, the free cash flow model

shows that Stanley Works as of November 1, 2007 is undervalued. According to

the sensitivity tests run, having a weighted average cost of capital of at least .1

and growth around -.1 would consider Stanley Works to be fairly valued within

15%. As supported with more accurate models to come, the idea of assuming a

negative growth can be based on the idea convergence; (discussed in the next RI

model) in other words Stanley Works should gradually converge with its market.

Residual Income Model

When comparing all the intrinsic valuations of a firm, the most reliable and

precise model to look at would be the residual income model which the theory of

the price to book ratio. This model values a firm by using the beginning book

values forecasted multiplied with its cost of equity to return a “benchmark” value

for its future income. From there one can compute future residual incomes, thus

ending with a very accurate price per share of the company. Looking at the past

few models each used perpetuities to value a firm while in this case the most

important factor is the forecasting of a firm’s earnings. Having inaccurate

earnings forecasts will give a completely different valuation of a company and

show no significance with the next valuation that will be mentioned, the abnormal

earnings growth model. Otherwise having accurate forecasts can and will result in

a very accurate view of a firm and its actual share value.

Being accurate in the earnings forecast is essential in this model. Here the

actual earnings were found by looking at the change in owner’s equity (Operating

– Investing cash flows) which should be consistent with each other. Other

important values used were the total dividends and beginning book values of

equity for the next ten years. Using beginning bock values of equity and

multiplying it be Ke gave the “normal” benchmark income for the next ten years.

Now, the residual income was computed by taking the difference in earnings and

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the forecasted benchmark earnings. Here, it can be seen if a firm either created

or destroyed value. In Stanley’s case, they tended to create value from year to

year because their earnings continued to grow more, relative to the growth in its

benchmark income. Like all the other models, the residual income was taken back

to the current year by multiplying it by the present value factor. Here is a table of

Stanley Works present value of its residual income for the upcoming future.

Sensitivity Analysis

Growth Rates 0 -0.05 -0.1 -0.2 -0.3

0.09 $82.68 $70.83 $65.21 $59.79 $57.15 0.1 $70.12 $62.04 $58.01 $53.97 $51.95 Under-valued > 66.18 0.12 $52.12 $48.44 $46.43 $44.30 $43.18 Fairly Valued with in 15%

Ke 0.135 $42.70 $40.77 $39.66 $38.44 $37.78 Overvalued < $48.92 0.15 $35.54 $34.66 $34.13 $33.52 $33.19

Looking at the numbers, the residual income looks to be decreasing year by

year. This is due the idea of convergence, meaning that a firm cannot sufficiently

continue having a high residual income. Therefore, a smaller ROE and negative

growth rates are common to see in the future, as the company’s residual income

converges to closer to the equilibrium.

Overall, this valuation can be understood to be the most accurate. Glancing

at the sensitivity analysis, the company’s tends to be overvalued. In order to

come closer to the observed stock price, the cost of equity would need to be

between 9% and 11% with a fairly low growth rate too. By doing so, Stanley

Works can be considered fairly valued within 15%. Thus, understanding that the

likely hood of having zero growth would not be very realistic in this industry in

order to survive and the idea of convergence discussed, Stanley Works should be

considered fairly valued.

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Long-run Residual Income Perpetuity

The following sensitivity models display three different long-run perpetuities

taken while holding one variable constant; return on equity (ROE), cost of equity

(Ke), or the growth rate (g). This model uses the essential variables in the

residual income model to accurately value the firm at perpetuity derived from the

price to book ratio (P/B) which the RI model based on.

Price (value of the firm) = BVE0*(1+ (ROE – Ke)/(Ke - g))

After, the long-run ROE and growth are determined, which will be

explained later, each variable can be manipulated to present a new value of the

firm. As done before, each value is then grown to November 1st of 2007 and

divided by the number of outstanding shares for accurate price per share. Thus,

the following sensitivity models show the effects of each variable change.

Sensitivity Analysis

ROE 0.15 0.17 0.19 0.21 0.23 Growth= -0.015 0.07 $51.84 $58.12 $64.41 $70.69 $76.97 $42.62 $47.78 $52.95 $58.12 $63.28 63.28 Under-valued > 66.18 $36.35 $40.75 $45.16 $49.56 $53.97 53.97 Fairly Valued with in 15% Ke $30.86 $34.60 $38.34 $42.08 $45.82 45.82 Overvalued < $48.92 $28.36 $31.80 $35.23 $38.67 $42.11 42.11

Growth Rate 0 -0.015 -0.05 -0.1 -0.2 Ke=.135 0.15 $31.17 $30.86 $30.33 $29.84 $29.31 0.17 $35.32 $34.60 $33.36 $32.23 $30.98 0.19 $39.48 $38.34 $36.39 $34.62 $32.66 Under-valued > 66.18 ROE 0.21 $43.63 $42.08 $39.42 $37.00 $34.33 Fairly Valued with in 15% 0.23 $47.79 $45.82 $42.46 $39.39 $36.01 Overvalued < $48.92

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Growth Rate 0 -0.015 -0.05 -0.1 -0.2 0.07 $64.86 $58.12 $48.96 $42.41 $36.60 ROE=.17 0.09 $51.23 $47.78 $42.62 $38.51 $34.60 0.11 $42.55 $40.75 $37.86 $35.40 $32.86 Under-valued > 66.18 Ke 0.135 $35.32 $34.60 $33.36 $32.23 $30.98 Fairly Valued with in 15% 0.15 $32.14 $31.80 $31.20 $30.63 $29.98 Overvalued < $48.92

Finding the ROE was fairly easy because the residual income model run

before already did that by taking forecasted earnings and dividing them by the

previous year’s book value of equity. This gave a ten year estimated return on

equity for Stanley and a reasonable assumption on what future ROE of 17% was

chosen to be held constant.

ROE 19.11% 19.16% 19.10% 18.96% 18.77% 18.53% 18.27% 18.00% 17.72% 17.45%

As for the growth assumption, a simple growth calculation used in the

residual income model gave an idea of what the long-run growth would be for

Stanley Co. The following were the growths found on the long-run return on

equity.

By examining the last four years, it was understandable to choose a growth

rate average of -1.5%. It is negative due to the idea mentioned before that a firm

can not continue with high residual incomes for too long and must be brought

back towards equilibrium.

All together now, inputting the two assumed variable (ROE, growth rate)

and the cost of equity (Ke) into the firm value formula mentioned early, a time

consistent price per share of $34.60 was determined.

These three sensitivity analysis are great support for the residual income

and abnormal earnings growth models concluding that Stanley Works is

Growth 0.3% -0.3% -0.7% -1.0% -1.3% -1.4% -1.5% -1.5% -1.5% -1.7%

114 | P a g e

overvalued. For the most part, Stanley was overvalued in the majority of the

analysis, but can be fairly valued if certain were changed, mainly by using a return

on equity of at least 17% and a growth rate of -1.5%. In conclusion, this analysis

can further support the idea that Stanley Works is overvalued

Abnormal Earnings Growth Valuation

The last valuation model used was the abnormal earnings growth which is

based upon expected future earnings over the current (forward) earnings, or the

P/E ratio. This model takes in account for the extra value for abnormal earnings

growth and the capitalized forward earnings, thus it is valuing the excess earnings

of a company. The sensitivity analysis for Stanley’s abnormal earnings growth

model is as followed.

Sensitivity Analysis

g 0 -0.05 -0.1 -0.2 -0.3 0.09 $108.89 $98.29 $93.28 $88.43 $86.07 0.1 $86.75 $80.27 $77.03 $73.79 $72.17 Under-valued > 66.18

Ke 0.12 $58.50 $56.08 $54.76 $53.36 $52.62 Fairly Valued with in 15% 0.135 $45.40 $44.31 $43.69 $43.00 $42.63 Over-valued < $48.92 0.15 $36.25 $35.85 $35.61 $35.34 $35.19

The greatest variation of this model compared to the others, is that it starts

two years out and discount all values back to year one values instead of year zero.

Therefore, starting in year two going forward the earning expected on the

reinvested dividends at the cost of equity (Drip), 13.5%. Then the difference

between cumulative dividends (Drip + earnings) and expected normal earnings

(earnings*1+Ke) were taken to find the abnormal earnings growth each year.

Like all models, the AEG values were taken back to year one by using the present

value factor. From here, a total of all present value AEGs were taken (69.69).

Going back now and looking at the AEG trend out to year ten, a year eleven

AEG growth was forecasted and grown perpetually and brought back to year one;

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leaving a present value of the terminal value (40.03). Furthermore, the total

present value of AEG can be found by summing the total of the PV AEGs and the

PV of terminal value. Then, the core earnings, or the forecasted time one

earnings at t=1(343.59), and total PV of AEG (109.72) were added together,

leaving the total average earning perpetuity to be 453.31. Finally, the total value

of equity was found by dividing the total average earning perpetuity by the cost of

equity (13.5%) and further divided it by the number of outstanding shares to

come up with an estimated price per share of $45.50.

In the sensitivity analysis, Stanley Works looks to be slightly overvalued.

Though, it was fairly easy to get within one dollar of the observed share price

using a 0% or –5% growth rate and dropping the cost of equity from 13.5% to

12%. This is support for Stanley Works being fairly valued through out the each

model and further explains how a slight change in one variable can cause a much

different result in the share price of a firm.

AEG and Residual Income Model Checks

A great thing about these last two models is how their results can be used

to check each other by observing the change in residual income and the abnormal

earnings growth amounts. Both values should be identical to each other to the

penny in order for the models to be completely correct. For example, the change

in residual income from year one and year two should be the exact amount of

abnormal earnings growth for year two. The table below displays how both

models conducted share identical values in each of their categories.

Abnormal Earnings Growth and Residual Income Check 2008 2009 2010 2011 2012 2013 2014 2015 2016 Annual AEG 25.94 28.45 31.31 34.55 38.23 42.40 47.15 52.55 58.69 Change in RI 25.94 28.45 31.31 34.55 38.23 42.40 47.15 52.55 58.69

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Knowing this check, it is reasonable to assume that both models should

have a similar estimated price per share for its company. Looking at both time

consistent values, they fall within three dollars of each other which is very good.

This displays that very likely as perpetuity were to be increased to infinity, there

would be a very small, if any, difference between these two estimated prices.

Finally, the only way that got a smaller difference between the two prices was to

slightly raise the cost of equity from 13.5% to 14% proving that both valuations

are much related to each other.

Conclusion

To conclude, observing the results from the previous theoretical valuations

models, it is suffice to say that Stanley Works is overvalued at the current

November 1, 2007 of $57.55. This result came from understanding that the two

most accurate models and the long-run residual declared Stanley share price

slightly overvalued ($42.70, $45.40, $34.60), but taking in consideration the little

significance the other two models carry, it is still reasonable to figure that free

cash flows and dividend models can explain for some added value that might need

to be taken in to account for when figuring Stanley Works actual share price.

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Credit Analysis

In order to determine where Stanley Works stands in regards to credit

worthiness, we used the Altman Z-Score model created by Edward Altman. The

model uses five basic financial ratios broken into eight variables (EBIT, Total

Assets, Sales, MVE, BVL, CA, CL, and RE) that are determined for that specific

year in order to determine the company’s risk of bankruptcy. A company with a

score lower than three would be considered risky and has a better chance of going

bankrupt. A score over three is said to be “healthy” and less likely to enter into a

bankruptcy. The following model can be used to interpret the Z- Score results:

Z-Score > 3.0 The company is safe based on these financial figures only. Z-Score between 2.7 and 2.99 On Alert. This zone is an area where one should exercise caution. Z-Score between 1.8 and 2.7

Good chances of the company going bankrupt within 2 years of operations from the date of financial figures given.

Z-Score < 1.8 Probability of Financial embarrassment is very high Interpretation created by creditguru.com

Based on the model above, Stanley Works credit score seems to be safe

based on these financial figures. Stanley Works Scores for the past five years are

as follows:

Year 2002 2003 2004 2005 2006

Z-Score 4.50 4.18 4.61 4.83 3.96

Conclusion

The previous data shows that Stanley works is above the borderline and in

a safe condition. The score seems to be comparatively consistent over time by

maintaining a score between four and five. An analyst would favor this score

based on the eight financial factors involved in determining the score. The model

used for calculation can be found in the appendix.

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Analyst Recommendation

After completely creating all models and looking at the accounting analysis,

financial analysis, forecasting, all valuations, and the industry as a whole. An

analyst can conclude that this firm is fairly valued as of November 1, 2007.

Comparing financials of Stanley Works and competitors: Black and Decker,

Snap-on, Danaher; the companies show similarities between key success factors.

The industry is fairly concentrated and competes on economies of scale, product

quality, brand image, research and development, and cost control.

Looking at all ratios in every aspect, the company has shown to follow

industry averages. The company also shows nothing alarming in sales and

expense diagnostics. This indicates that the management is not trying to hide

anything by manipulating parts of the financials.

In forecasting future earnings and other line items of the financial

statements, we chose to use a conservative approach and feel that growths are an

accurate determination in which to forecast by and to use in valuations. When

determining the value of the firm’s equity, most models have shown that the firm

is either undervalued or fairly valued with the exception of an outlier. However,

some intrinsic valuations have shown Stanley Works to be overvalued in a zero

growth model. By slight manipulations in growth, the analyst can draw the same

conclusion that the firm is fairly valued. Overall conclusions imply that the

company is just an average company, not rising above or below the industry and

has a fair market value of $57.55.

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Appendix

3 Month Regression

SUMMARY OUTPUT 72 mth

Regression Statistics

Multiple R 0.50903122

8

R Square 0.25911279

1

Adjusted R Square 0.24852868

8

Standard Error 0.06026253

4

Observations 72

ANOVA

df SS MS F Significance F

Regression 1 0.088905692 0.08890569

2 24.4813180

2 4.9726E-06

Residual 70 0.254210107 0.00363157

3

Total 71 0.343115799

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0%

Upper 95.0%

Intercept 0.00572266

7 0.007225937 0.79196196

5 0.43105850

2 -0.008689009 0.02013434

4

-0.00868900

9 0.02013434

4

X Variable 1 0.99852954

6 0.20181039 4.94785994

4 4.9726E-06 0.596031419 1.40102767

2 0.59603141

9 1.40102767

2

SUMMARY OUTPUT 60 mth

Regression Statistics

Multiple R 0.60139979

9

R Square 0.36168171

9

Adjusted R Square 0.35067623

1

Standard Error 0.05378663

1

Observations 60

ANOVA

df SS MS F Significance F

Regression 1 0.095074918 0.09507491

8 32.8637614 3.74367E-07

Residual 58 0.167794099 0.00289300

2

Total 59 0.262869017

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0%

Upper 95.0%

Intercept 0.01221916

5 0.007558638 1.61658293

1 0.11139511

4 -0.002911093 0.02734942

3

-0.00291109

3 0.02734942

3

X Variable 1 1.55745211

8 0.271679 5.73269233

4 3.74367E-

07 1.013627519 2.10127671

7 1.01362751

9 2.10127671

7

SUMMARY OUTPUT 48 mth

Regression Statistics

Multiple R 0.60910496

9

R Square 0.37100886

120 | P a g e

3

Adjusted R Square 0.35733514

3

Standard Error 0.03946103

8

Observations 48

ANOVA

df SS MS F Significance F

Regression 1 0.042250766 0.04225076

6 27.1329859

8 4.34624E-06

Residual 46 0.07162998 0.00155717

3

Total 47 0.113880747

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0%

Upper 95.0%

Intercept 0.00658017

7 0.006318402 1.04143063

9 0.30311853

1 -0.006138106 0.01929846

1

-0.00613810

6 0.01929846

1

X Variable 1 1.40313874

5 0.26937161 5.20893328

6 4.34624E-

06 0.860921826 1.94535566

5 0.86092182

6 1.94535566

5

SUMMARY OUTPUT 36mth

Regression Statistics

Multiple R 0.64029737

5

R Square 0.40998072

9

Adjusted R Square 0.39262722

1

Standard Error 0.03677016

2

Observations 36

ANOVA

df SS MS F Significance F

Regression 1 0.031942379 0.03194237

9 23.6252364

4 2.60246E-05

Residual 34 0.045969525 0.00135204

5

Total 35 0.077911904

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0%

Upper 95.0%

Intercept 0.01230349 0.006935112 1.77408662

2 0.08500528

2 -0.001790354 0.02639733

3

-0.00179035

4 0.02639733

3

X Variable 1 1.39917531

9 0.287861811 4.86057984

6 2.60246E-

05 0.814169736 1.98418090

1 0.81416973

6 1.98418090

1

SUMMARY OUTPUT 24 mth

Regression Statistics

Multiple R 0.60774315

2

R Square 0.36935173

9

Adjusted R Square 0.34068590

9

Standard Error 0.04049751

7

Observations 24

ANOVA

df SS MS F Significance F

Regression 1 0.021131602 0.02113160

2 12.8847390

4 0.00163213

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Residual 22 0.036081076 0.00164004

9

Total 23 0.057212678

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0%

Upper 95.0%

Intercept 0.01583734

2 0.009880791 1.60284157 0.12323140

6 -0.004654164 0.03632884

8

-0.00465416

4 0.03632884

8

X Variable 1 1.47465789

3 0.410821786 3.58953187 0.00163213 0.62266566 2.32665012

6 0.62266566 2.32665012

6

1 Year Regression SUMMARY OUTPUT 72 mth

Regression Statistics

Multiple R 0.508980218 R Square 0.259060863 Adjusted R Square 0.248476018 Standard Error 0.060264645 Observations 72

ANOVA

df SS MS F Significance

F

Regression 1 0.088887875 0.088887875 24.47469633 4.98527E-06 Residual 70 0.254227924 0.003631827 Total 71 0.343115799

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.005961888 0.007235289 0.824001406 0.412737555 -0.00846844 0.020392217 -0.00846844 0.020392217 X Variable 1 1.000016622 0.202138279 4.947190751 4.98527E-06 0.596864543 1.403168702 0.596864543 1.403168702

SUMMARY OUTPUT 60 mth

Regression Statistics

Multiple R 0.601575398 R Square 0.361892959 Adjusted R Square 0.350891114 Standard Error 0.053777731 Observations 60

ANOVA

df SS MS F Significance

F

Regression 1 0.095130446 0.095130446 32.89384113 3.70691E-07 Residual 58 0.167738571 0.002892044 Total 59 0.262869017

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.012575884 0.007581823 1.658688688 0.102577457 -

0.002600783 0.027752552 -

0.002600783 0.027752552 X Variable 1 1.560293023 0.272050088 5.73531526 3.70691E-07 1.015725609 2.104860437 1.015725609 2.104860437

SUMMARY OUTPUT 48 mth

Regression Statistics

Multiple R 0.608994259

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R Square 0.370874007 Adjusted R Square 0.357197355 Standard Error 0.039465268 Observations 48

ANOVA

df SS MS F Significance

F

Regression 1 0.042235409 0.042235409 27.11730962 4.36844E-06 Residual 46 0.071645338 0.001557507 Total 47 0.113880747

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.006921946 0.006347985 1.09041618 0.281208954 -

0.005855886 0.019699777 -

0.005855886 0.019699777 X Variable 1 1.405485264 0.26990007 5.207428312 4.36844E-06 0.86220461 1.948765918 0.86220461 1.948765918

SUMMARY OUTPUT 36 mth

Regression Statistics

Multiple R 0.63946809 R Square 0.408919438 Adjusted R Square 0.391534716 Standard Error 0.036803217 Observations 36

ANOVA

df SS MS F Significance

F

Regression 1 0.031859692 0.031859692 23.52176976 2.68627E-05 Residual 34 0.046052212 0.001354477 Total 35 0.077911904

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.012542767 0.006966575 1.800420987 0.080671723 -

0.001615016 0.02670055 -

0.001615016 0.02670055 X Variable 1 1.399395351 0.288539603 4.849924717 2.68627E-05 0.813012331 1.985778371 0.813012331 1.985778371

SUMMARY OUTPUT 24 mth

Regression Statistics

Multiple R 0.60609147 R Square 0.36734687 Adjusted R Square 0.33858991 Standard Error 0.040561838 Observations 24

ANOVA

df SS MS F Significance

F

Regression 1 0.021016898 0.021016898 12.77418978 0.001693922 Residual 22 0.03619578 0.001645263 Total 23 0.057212678

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.015921874 0.009917584 1.605418587 0.122661677 -

0.004645937 0.036489685 -

0.004645937 0.036489685 X Variable 1 1.472150367 0.411894023 3.574099856 0.001693922 0.61793445 2.326366283 0.61793445 2.326366283

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2 Year regressions SUMMARY OUTPUT 72 mth

Regression Statistics Multiple R 0.509222515 R Square 0.259307569 Adjusted R Square 0.248726249 Standard Error 0.060254612 Observations 72 ANOVA

df SS MS F Significance

F Regression 1 0.088972524 0.088972524 24.50616355 4.92537E-06 Residual 70 0.254143275 0.003630618 Total 71 0.343115799

Coefficients Standard

Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.006215302 0.0072439 0.858004931 0.393818052 -

0.008232201 0.020662805 -

0.008232201 0.020662805 X Variable 1 1.00282519 0.202575804 4.950370042 4.92537E-06 0.598800495 1.406849886 0.598800495 1.406849886 SUMMARY OUTPUT 60 mth

Regression Statistics Multiple R 0.601991577 R Square 0.362393859 Adjusted R Square 0.35140065 Standard Error 0.053756619 Observations 60 ANOVA

df SS MS F Significance

F Regression 1 0.095262118 0.095262118 32.96524688 3.62115E-07 Residual 58 0.1676069 0.002889774 Total 59 0.262869017

Coefficients Standard

Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.012863163 0.007598235 1.692914698 0.095837132 -

0.002346356 0.028072682 -

0.002346356 0.028072682 X Variable 1 1.563166232 0.272255711 5.741536979 3.62115E-07 1.01818722 2.108145244 1.01818722 2.108145244 SUMMARY OUTPUT 48 mth

Regression Statistics Multiple R 0.610317671 R Square 0.37248766 Adjusted R Square 0.358846087 Standard Error 0.039414623 Observations 48 ANOVA

df SS MS F Significance

F Regression 1 0.042419173 0.042419173 27.3053313 4.10981E-06 Residual 46 0.071461574 0.001553512 Total 47 0.113880747

Coefficients Standard

Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.007163537 0.006357668 1.12675542 0.265689593 -

0.005633785 0.019960859 -

0.005633785 0.019960859 X Variable 1 1.411175897 0.270058235 5.225450344 4.10981E-06 0.867576873 1.954774922 0.867576873 1.954774922 SUMMARY OUTPUT 36 mth

Regression Statistics Multiple R 0.638933586 R Square 0.408236127 Adjusted R Square 0.390831308 Standard Error 0.036824484 Observations 36

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ANOVA

df SS MS F Significance

F Regression 1 0.031806454 0.031806454 23.4553493 2.74158E-05 Residual 34 0.04610545 0.001356043 Total 35 0.077911904

Coefficients Standard

Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.012585545 0.006976106 1.804093124 0.080082582 -

0.001591608 0.026762698 -

0.001591608 0.026762698 X Variable 1 1.400639916 0.289204833 4.843072299 2.74158E-05 0.812904985 1.988374847 0.812904985 1.988374847 SUMMARY OUTPUT 24 mth

Regression Statistics Multiple R 0.604992584 R Square 0.366016027 Adjusted R Square 0.337198574 Standard Error 0.040604478 Observations 24 ANOVA

df SS MS F Significance

F Regression 1 0.020940757 0.020940757 12.70119267 0.001736131 Residual 22 0.036271921 0.001648724 Total 23 0.057212678

Coefficients Standard

Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.015780266 0.009911633 1.59209553 0.125631007 -

0.004775202 0.036335734 -

0.004775202 0.036335734 X Variable 1 1.471954967 0.413021131 3.563873268 0.001736131 0.615401571 2.328508362 0.615401571 2.328508362

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5 Year Regressions

SUMMARY OUTPUT 72 mth

Regression Statistics Multiple R 0.509698208 R Square 0.259792263 Adjusted R Square 0.249217867 Standard Error 0.060234894 Observations 72 ANOVA

df SS MS F Significance

F Regression 1 0.08913883 0.08913883 24.56804698 4.80972E-06 Residual 70 0.253976969 0.003628242 Total 71 0.343115799

Coefficients Standard

Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.006786762 0.007264906 0.934184444 0.353420156 -

0.007702636 0.02127616 -

0.007702636 0.02127616 X Variable 1 1.005408433 0.202841684 4.956616485 4.80972E-06 0.600853457 1.40996341 0.600853457 1.40996341 SUMMARY OUTPUT 60 mth

Regression Statistics Multiple R 0.602540318 R Square 0.363054835 Adjusted R Square 0.352073022 Standard Error 0.053728749 Observations 60 ANOVA

df SS MS F Significance

F Regression 1 0.095435868 0.095435868 33.05964408 3.51091E-07 Residual 58 0.167433149 0.002886778 Total 59 0.262869017

Coefficients Standard

Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.013594691 0.007645793 1.77806152 0.080635702 -

0.001710027 0.028899409 -

0.001710027 0.028899409 X Variable 1 1.564239474 0.272053398 5.749751654 3.51091E-07 1.019665435 2.108813513 1.019665435 2.108813513 SUMMARY OUTPUT 48 mth

Regression Statistics Multiple R 0.613903387 R Square 0.376877369 Adjusted R Square 0.363331225 Standard Error 0.03927652 Observations 48 ANOVA

df SS MS F Significance

F Regression 1 0.042919076 0.042919076 27.82174507 3.47857E-06 Residual 46 0.07096167 0.001542645 Total 47 0.113880747

Coefficients Standard

Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.007716506 0.006375307 1.210374002 0.232318208 -

0.005116322 0.020549334 -

0.005116322 0.020549334 X Variable 1 1.421226732 0.269445655 5.274632221 3.47857E-06 0.878860768 1.963592696 0.878860768 1.963592696 SUMMARY OUTPUT 36 mth

Regression Statistics Multiple R 0.638460934 R Square 0.407632364

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Adjusted R Square 0.390209787 Standard Error 0.036843265 Observations 36 ANOVA

df SS MS F Significance

F Regression 1 0.031759413 0.031759413 23.39678868 2.79135E-05 Residual 34 0.04615249 0.001357426 Total 35 0.077911904

Coefficients Standard

Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.012687782 0.00699091 1.814896906 0.078370408 -

0.001519458 0.026895021 -

0.001519458 0.026895021 X Variable 1 1.399890989 0.289411705 4.837022708 2.79135E-05 0.811735644 1.988046334 0.811735644 1.988046334 SUMMARY OUTPUT 24 mth

Regression Statistics Multiple R 0.60425224 R Square 0.365120769 Adjusted R Square 0.336262622 Standard Error 0.040633137 Observations 24 ANOVA

df SS MS F Significance

F Regression 1 0.020889537 0.020889537 12.65225972 0.001765071 Residual 22 0.036323141 0.001651052 Total 23 0.057212678

Coefficients Standard

Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.015720732 0.009913108 1.585852941 0.127042772 -

0.004837796 0.03627926 -

0.004837796 0.03627926 X Variable 1 1.470846165 0.413507321 3.557001507 0.001765071 0.613284472 2.328407859 0.613284472 2.328407859

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7 Year Regressions

SUMMARY OUTPUT 72 mth

Regression Statistics Multiple R 0.509703513 R Square 0.259797671 Adjusted R Square 0.249223352 Standard Error 0.060234674 Observations 72 ANOVA

df SS MS F Significance

F Regression 1 0.089140685 0.089140685 24.5687378 4.80845E-06 Residual 70 0.253975114 0.003628216 Total 71 0.343115799

Coefficients Standard

Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.007032744 0.00727559 0.966621715 0.337060999 -

0.007477964 0.021543451 -

0.007477964 0.021543451 X Variable 1 1.00580603 0.202919046 4.956686171 4.80845E-06 0.601096759 1.410515302 0.601096759 1.410515302 SUMMARY OUTPUT 60 mth

Regression Statistics Multiple R 0.602453686 R Square 0.362950444 Adjusted R Square 0.351966831 Standard Error 0.053733151 Observations 60 ANOVA

df SS MS F Significance

F Regression 1 0.095408426 0.095408426 33.04472241 3.5281E-07 Residual 58 0.167460591 0.002887252 Total 59 0.262869017

Coefficients Standard

Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.013923437 0.007670851 1.81510995 0.074678422 -

0.001431438 0.029278313 -

0.001431438 0.029278313 X Variable 1 1.563647093 0.272011765 5.748453914 3.5281E-07 1.019156392 2.108137794 1.019156392 2.108137794 SUMMARY OUTPUT 48 mth

Regression Statistics Multiple R 0.615183811 R Square 0.378451122 Adjusted R Square 0.364939189 Standard Error 0.03922689 Observations 48 ANOVA

df SS MS F Significance

F Regression 1 0.043098296 0.043098296 28.00866061 3.27584E-06 Residual 46 0.07078245 0.001538749 Total 47 0.113880747

Coefficients Standard

Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.007964754 0.00638604 1.247213319 0.218632096 -

0.004889677 0.020819186 -

0.004889677 0.020819186 X Variable 1 1.424444401 0.269153066 5.29232091 3.27584E-06 0.882667387 1.966221415 0.882667387 1.966221415

128 | P a g e

SUMMARY OUTPUT 36 mth

Regression Statistics Multiple R 0.638370455 R Square 0.407516838 Adjusted R Square 0.390090862 Standard Error 0.036846858 Observations 36 ANOVA

df SS MS F Significance

F Regression 1 0.031750413 0.031750413 23.38559703 2.80097E-05 Residual 34 0.046161491 0.001357691 Total 35 0.077911904

Coefficients Standard

Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.012774987 0.007000457 1.824879016 0.076816209 -

0.001451653 0.027001628 -

0.001451653 0.027001628 X Variable 1 1.399475542 0.289395039 4.835865696 2.80097E-05 0.811354066 1.987597019 0.811354066 1.987597019 SUMMARY OUTPUT 24 mth

Regression Statistics Multiple R 0.604100525 R Square 0.364937445 Adjusted R Square 0.336070965 Standard Error 0.040639003 Observations 24 ANOVA

df SS MS F Significance

F Regression 1 0.020879048 0.020879048 12.6422566 0.001771052 Residual 22 0.036333629 0.001651529 Total 23 0.057212678

Coefficients Standard

Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.015745977 0.009919177 1.587427722 0.126685395 -

0.004825137 0.036317091 -

0.004825137 0.036317091 X Variable 1 1.470474553 0.413566367 3.555595113 0.001771052 0.612790407 2.328158699 0.612790407 2.328158699

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10 Year Regressions SUMMARY OUTPUT 72 mth

Regression Statistics Multiple R 0.509848384 R Square 0.259945375 Adjusted R Square 0.249373166 Standard Error 0.060228664 Observations 72 ANOVA

df SS MS F Significance

F Regression 1 0.089191365 0.089191365 24.5876123 4.77374E-06 Residual 70 0.253924434 0.003627492 Total 71 0.343115799

Coefficients Standard

Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.007243067 0.007284176 0.994356467 0.323474257 -

0.007284763 0.021770898 -

0.007284763 0.021770898 X Variable 1 1.005989439 0.202878135 4.95858975 4.77374E-06 0.601361763 1.410617115 0.601361763 1.410617115 SUMMARY OUTPUT 60 mth

Regression Statistics Multiple R 0.602680444 R Square 0.363223718 Adjusted R Square 0.352244816 Standard Error 0.053721625 Observations 60 ANOVA

df SS MS F Significance

F Regression 1 0.095480262 0.095480262 33.08379445 3.48327E-07 Residual 58 0.167388755 0.002886013 Total 59 0.262869017

Coefficients Standard

Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.014242929 0.007692546 1.851523443 0.069187141 -

0.001155374 0.029641233 -

0.001155374 0.029641233 X Variable 1 1.563578608 0.271839187 5.751851393 3.48327E-07 1.019433359 2.107723858 1.019433359 2.107723858 SUMMARY OUTPUT 48 mth

Regression Statistics Multiple R 0.61633474 R Square 0.379868512 Adjusted R Square 0.366387393 Standard Error 0.039182138 Observations 48 ANOVA

df SS MS F Significance

F Regression 1 0.04325971 0.04325971 28.17781696 3.10302E-06 Residual 46 0.070621037 0.00153524 Total 47 0.113880747

Coefficients Standard

Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.00822229 0.006398759 1.284981878 0.205231358 -

0.004657745 0.021102324 -

0.004657745 0.021102324 X Variable 1 1.427274291 0.268877073 5.308278154 3.10302E-06 0.886052823 1.968495759 0.886052823 1.968495759

130 | P a g e

SUMMARY OUTPUT 36 mth

Regression Statistics Multiple R 0.638336788 R Square 0.407473855 Adjusted R Square 0.390046615 Standard Error 0.036848194 Observations 36 ANOVA

df SS MS F Significance

F Regression 1 0.031747064 0.031747064 23.38143419 2.80456E-05 Residual 34 0.04616484 0.001357789 Total 35 0.077911904

Coefficients Standard

Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.012892237 0.007012469 1.838473415 0.074741846 -

0.001358814 0.027143289 -

0.001358814 0.027143289 X Variable 1 1.399196852 0.289363165 4.835435264 2.80456E-05 0.811140152 1.987253551 0.811140152 1.987253551 SUMMARY OUTPUT 24 mth

Regression Statistics Multiple R 0.60391714 R Square 0.364715912 Adjusted R Square 0.335839363 Standard Error 0.040646091 Observations 24 ANOVA

df SS MS F Significance

F Regression 1 0.020866374 0.020866374 12.63017637 0.001778305 Residual 22 0.036346304 0.001652105 Total 23 0.057212678

Coefficients Standard

Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.015803899 0.00993076 1.59140881 0.125785667 -

0.004791237 0.036399034 -

0.004791237 0.036399034 X Variable 1 1.469833891 0.413583829 3.553895942 0.001778305 0.612113531 2.327554251 0.612113531 2.327554251

Gross Profit Margin 2002 2003 2004 2005 2006

SWK 0.33

0.34

0.37

0.36

0.36

DHR

131 | P a g e

0.39 0.40 0.42 0.43 0.44

SNA 0.46

0.43

0.43

0.44

0.44

BDK 0.35

0.36

0.36

0.36

0.35

Industry Avg. 0.38

0.38

0.40

0.40

0.40

Operating Expense Ratio 2002 2003 2004 2005 2006

SWK 0.22

0.23

0.23

0.22

0.24

DHR 0.24 0.25 0.26 0.27 0.29 SNA 0.38 0.38 0.39 0.37 0.36

BDK 0.25

0.25

0.25

0.23

0.23

Industry Avg. 0.27

0.28

0.28

0.27

0.28

Operating Profit Margin 2002 2003 2004 2005 2006

SWK 0.11

0.11

0.14

0.14

0.13

DHR 0.15

0.16

0.16

0.16

0.16

SNA 0.09

0.07

0.06

0.07

0.07

BDK 0.09

0.10

0.11

0.12

0.11

Industry Avg. 0.11

0.11

0.12

0.12

0.12

Net Profit Margin 2002 2003 2004 2005 2006

SWK 0.08

0.04

0.12

0.08

0.07

DHR 0.06

0.10

0.11

0.11

0.12

SNA 0.05

0.04

0.04

0.04

0.04

BDK 0.05

0.07

0.08

0.08

0.08

Industry Avg. 0.06

0.06

0.09

0.08

0.08

Asset Turnover 2002 2003 2004 2005 2006

SWK 0.92

1.03

1.05

0.93

1.02

DHR 0.76

0.77

0.81

0.87

0.75

SNA 1.06

1.04

1.02

1.15

0.93

BDK 1.04

1.06

0.98

1.12

1.23

Industry Avg. 0.95

0.97

0.97

1.02

0.98

Return on Assets 2002 2003 2004 2005 2006

SWK 0.08

0.04

0.13

0.08

0.07

DHR 0.05

0.08

0.09

0.10

0.09

SNA 0.05

0.04

0.04

0.04

0.05

BDK 0.06

0.07

0.08

0.09

0.09

Industry Avg. 0.06

0.06

0.08

0.08

0.08

Return on Equity 2002 2003 2004 2005 2006

SWK 0.19

0.12

0.30

0.19

0.19

DHR 0.10

0.15

0.16

0.18

0.17

SNA 0.13

0.08

0.07

0.08

0.10

BDK 0.38

0.35

0.29

0.34

0.42

Industry Avg. 0.20

0.18

0.21

0.20

0.22

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WACC

Cost of Debt & Z-Score Model Liabilities and Shareowners Equity 2002 2003 2004 2005 2006 Interest Rates Weight Kd Current Liabilities Short-term borrowings 140.10 47.10 148.10 89.70 4.70% 3.76% 0.18% Current maturities of long-term debt 8.60 157.70 55.40 22.10 230.30 4.20% 9.66% 0.41% Accounts payable 238.90 222.20 297.90 327.70 445.20 4.50% 18.68% 0.84% Accrued expenses 266.50 314.30 417.00 374.30 485.90 4.20% 20.39% 0.86% Liabilities held for sale 27.90 62.50 3.70 3.10 Total Current Liabilities 682.00 756.70 821.10 875.30 1251.10 Long-Term Debt 563.20 513.60 481.80 895.30 679.20 4.90% 28.50% 1.40% Deferred Taxes 81.60 72.30 83.40 67.20 4.50% 2.82% 0.13%

Other Liabilities 189.20 202.80 238.70 246.20 385.90 6.00% 16.19% 0.97%

Total Liabilities 1434.40 1554.70 1613.90 2100.20 2383.40 AVG Kd 4.77%

Year 2002 2003 2004 2005 2006Z-Score 4.50 4.18 4.61 4.83 3.96Z- Score= 1.2(Working Capital/Total Assets)+

1.4(Retained Earning/Total Assets)+

3.3(EBIT/Total Assets)+ .6(MVE/BVL)+ 1(Sales/Total Assets)

Liquidity Ratios

2007 Current Ratio 2002 2003 2004 2005 2006 Q1 Q2 Q3

SWK 1.78 1.63 1.67 2.09 1.31 1.34 1.34 1.38

DHR 1.89 2.13 1.33 1.3 1.38 SNA 1.91 1.99 1.77 2.12 1.63 BDK 1.51 1.68 1.63 1.49 1.52

PPS 50.29 WACC AT= 9.95%

# Shares 81,841,627 WACC BT= 10.31%

Ve 4115.8 Vd 2383.4 Kd 4.77% Ke 13.52% Tax rate 20.60% Value of firm 6499.2

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Industry Avg. 1.77 1.86 1.6 1.75 1.46 2007 Quick Asset Ratio 2002 2003 2004 2005 2006 Q1 Q2 Q3

SWK 0.96 0.88 1.01 1.45 0.74 0.78 0.81 0.85

DHR 1.24 1.52 0.84 0.76 0.81 SNA 1.04 1.13 1.03 1.89 0.91 BDK 0.36 0.23 0.29 0.43 0.13 Industry Avg. 0.9 0.94 0.79 1.13 0.65 2007 Inventory Turnover 2002 2003 2004 2005 2006 Q1 Q2 Q3

SWK 3.64 4.52 4.65 4.57 4.27 1.07 1.11 1.12

DHR 5.75 5.88 5.68 5.5 5.32 SNA 3.09 3.61 3.86 4.55 4.3 BDK 3.87 4.07 3.5 4.01 3.95 Industry Avg. 4.09 4.52 4.42 4.66 4.46 2007 Inventory Days 2002 2003 2004 2005 2006 Q1 Q2 Q3

SWK 100.32 80.71 78.5 79.92 85.39 85.28 82.21 81.47

DHR 63.5 62.04 64.29 66.35 68.55 SNA 117.99 101.02 94.55 80.22 84.88 BDK 94.41 89.75 104.39 91.03 92.3 Industry Avg. 94.05 83.38 85.43 79.38 82.78 2007 Recievables Turnover 2002 2003 2004 2005 2006 Q1 Q2 Q3

SWK 4.17 5.37 5.21 5.39 5.36 1.32 1.31 1.25

DHR 6.03 6.1 5.6 5.67 5.73 SNA 3.79 4.08 4.29 4.75 4.42 BDK 6 5.54 5.16 5.77 5.61 Industry Avg. 5 5.27 5.06 5.39 5.28 2007 Working Capital Turnover 2002 2003 2004 2005 2006 Q1 Q2 Q3

SWK 4.22 5.18 5.41 3.46 10.37 2.38 2.51 2.17

DHR 4.08 3.39 9.62 11.8 10.26 SNA 4.23 3.96 4.49 4.07 5.74 BDK 5.8 5.03 4.76 5.95 6.98 Industry Avg. 4.58 4.39 6.07 6.32 8.34

Liquidity Ratios Cont…

2007 A/R Days 2002 2003 2004 2005 2006 Q1 Q2 Q3

SWK 87.57 67.96 70.07 67.73 68.08 69.13 69.66 73.00

DHR 60.53 59.84 65.18 64.37 63.70 SNA 96.31 89.46 85.08 76.84 82.58 BDK 60.83 65.88 70.74 63.26 65.06

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Industry Avg. 76.31 70.79 72.77 68.05 69.86 2007 Cash to Cash Cycle 2002 2003 2004 2005 2006 Q1 Q2 Q3

SWK 187.89 148.67 148.57 147.65 153.47 154.41 151.86 154.47

DHR 124.03 121.88 129.47 130.72 132.25 SNA 214.30 190.48 179.63 157.06 167.46 BDK 155.24 155.63 175.13 154.29 157.36 Industry Avg. 170.37 154.17 158.20 147.43 152.64

SGR/ IGR SGR 2002 2003 2004 2005 2006

SWK 0.10

0.03

0.22

0.12

0.12

DHR 0.10

0.15

0.17

0.18

0.17

SNA 0.06 0.02 0.02 0.03 0.04

BDK 0.45

0.40

0.33

0.40

0.51

Industry Avg. 0.18

0.15

0.19

0.18

0.21

IGR 2002 2003 2004 2005 2006

SWK 0.51

0.50

0.51

0.47

0.48

DHR 0.36

0.39

0.41

0.47

0.42

SNA 0.53

0.51

0.48

0.47

0.44

BDK 0.13

0.18

0.21

0.26

0.28

Industry Avg. 0.38

0.40

0.40

0.42

0.40

Capital Structure Ratios Debt to Equity Ratio 2002 2003 2004 2005 2006

SWK 1.46

1.79

1.31

1.45

1.54

DHR 1.00

0.89

0.84

0.80

0.94

SNA 1.44

1.15

1.02

1.09

1.47

BDK 5.89

3.99

2.55

2.74

3.51

Industry Avg.

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2.45 1.95 1.43 1.52 1.86 Times Interest Earned 2002 2003 2004 2005 2006

SWK 8.87

8.00

10.68

11.00

7.26

DHR 12.19

13.50

19.24

27.47

18.12

SNA 6.62

5.78

6.24

7.74

8.01

BDK 5.28

11.11

26.62

17.65

9.00

Industry Avg. 8.24

9.60

15.70

15.97

10.60

Debt Service Margin 2002 2003 2004 2005 2006

SWK 1.92

2.94

3.62

2.13

1.37

DHR 1.94

1.82

1.69

1.54

1.62

SNA 3.97

5.86

1.15

1.73

8.20

BDK 1.34

1.50

1.29

1.32

1.36

Industry Avg. 1.96

2.66

1.62

1.35

2.80

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Summary of Stanley Works Ratios

2007 Stanley Works Trend Analysis 2002 2003 2004 2005 2006 Q1 Q2 Q3

LIQUIDITY Current Ratio 1.78 1.63 1.67 2.09 1.31 1.34 1.34 1.38Quick Asset Ratio 0.96 0.88 1.01 1.45 0.74 0.78 0.81 0.85Inventory Turnover 3.64 4.52 4.65 4.57 4.27 1.07 1.11 1.12Inventory Days 100.32 80.71 78.50 79.92 85.39 85.28 82.21 81.47Recievables Turnover 4.17 5.37 5.21 5.39 5.36 1.32 1.31 1.25Working Capital Turnover 4.22 5.18 5.41 3.46 10.37 2.38 2.51 2.17A/R Days 87.57 67.96 70.07 67.73 68.08 69.13 69.66 73.00Cash to Cash Cycle 187.89 148.67 148.57 147.65 153.47 154.41 151.86 154.47

Profitablilty Gross Profit Margin 33.46% 34.21% 36.82% 35.96% 36.29% Operating Expense Ratio 22.31% 23.23% 23.06% 22.43% 23.77% Operating Profit Margin 11.15% 10.98% 13.76% 13.53% 12.52% Net Profit Margin 8.28% 4.34% 12.24% 8.21% 7.20% Asset Turnover 92.40% 102.55% 105.15% 92.67% 102.11% Return on Assets 7.65% 4.45% 12.87% 7.60% 7.36% Return on Equity 18.80% 12.42% 29.67% 18.66% 18.65%

Capital Structure Debt to Equity Ratio 1.46 1.79 1.31 1.45 1.54 Times Interest Earned 8.87 8.00 10.68 11.00 7.26 Debt Service Margin 1.92 2.94 3.62 2.13 1.37

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References finance.yahoo.com

Firstresearch.com

Googlefinance.com

Stanleyworks.com

Popsci.com

Businessinnovationsinsider.com

Text: Business Analysis & Valuation

Netmba.com

Lexdon.com

Phx.corporate-ir.net

Investopedia.com

Reuters.com

Investorswords.com

Vitalentusa.com

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