Discounted Dividend Valuation
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Transcript of Discounted Dividend Valuation
DISCOUNTED DIVIDEND VALUATION
PresenterVenueDate
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DISCOUNTED CASH FLOW MODELS
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CHOICE OF DISCOUNTED CASH FLOW MODELS
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VALUING COMMON STOCK USING A MULTI-PERIOD DDM
EXAMPLE: VALUING COMMON STOCK USING A MULTPERIOD DDM
0 1 2 3
D $1.00 $1.05 $1.10
P $20.00
EXAMPLE: VALUING COMMON STOCK USING A MULTPERIOD DDM
0 2 3
0
$1.00 $1.05 $21.101.10 1.10 1.10
$17.63
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V
VALUING COMMON STOCK USING THE GORDON GROWTH MODEL
0 10
(1 )
D g D
Vr g r g
EXAMPLE: VALUING COMMON STOCK USING THE GORDON GROWTH MODEL
Risk-free rate 3.0%
Equity risk premium 6.0%
Beta 1.20
Current dividend $2.00
Dividend growth rate 5.0%
Current stock price $24 .00
VALUING COMMON STOCK USING THE GORDON GROWTH MODEL
0$2.00(1 0.05) $2.10 $40.38
0.102 0.05 0.102 0.05
V
CAPM: = 3% + 1.2(6%) = 10.2%r
EXAMPLE: VALUING PREFERRED STOCK
0$2.00 $19.61
0.102 0
V
EXAMPLE: CALCULATING THE IMPLIED GROWTH RATE USING THE GORDON GROWTH MODEL
$2.00(1 )$240.102
2.448 24 2.00(1 )26 0.448
1.72%
gg
g gg
g
Using the previous common stock example and the current stock price of $24, what is the implied growth rate?
CALCULATING THE IMPLIED REQUIRED RETURN USING THE GORDON GROWTH MODEL
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0
DV
r gD
r gP
EXAMPLE: CALCULATING THE IMPLIED REQUIRED RETURN USING THE GORDON GROWTH MODEL
Using the previous common stock example and the current stock price of $24, what is the implied required return?
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2.10 0.0524
8.75% 5% 13.75%
Dr g
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PRESENT VALUE OF GROWTH OPPORTUNITIES
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10
PVGO
PVGO
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rE
Pr
PRESENT VALUE OF GROWTH OPPORTUNITIES
10
0
1 1
PVGO
1 PVGO
EV
rPE r E
EXAMPLE: PRESENT VALUE OF GROWTH OPPORTUNITIES
Stock price $80 .00
Expected earnings $5 .00
Required return on stock 10%
EXAMPLE: PRESENT VALUE OF GROWTH OPPORTUNITIES
10PVGO
5PVGO $80 $300.10
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r
EXAMPLE: PRESENT VALUE OF GROWTH OPPORTUNITIES
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0
1 PVGO
1 300.10 5
16 10 6
PE r EPE
USING THE GORDON GROWTH MODEL TO DERIVE A JUSTIFIED LEADING P/E
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0 1 1
1
0
1
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DV
r gP D EE r gP bE r g
USING THE GORDON GROWTH MODEL TO DERIVE A JUSTIFIED TRAILING P/E
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0 0 0
0
0
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(1 )
(1 )(1 )
D gV
r gP D g EE r gP b gE r g
EXAMPLE: USING THE GORDON GROWTH MODEL TO DERIVE A JUSTIFIED P/E
Stock price $50 .00
Trailing earnings per share $4 .00
Current dividends per share $1.60
Dividend growth rate 5.0%
Required return on stock 9.0%
EXAMPLE: USING THE GORDON GROWTH MODEL TO DERIVE A JUSTIFIED LEADING P/E
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0
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$1.60 $4.00 10.00.09 0.05
P bE r gPE
EXAMPLE: USING THE GORDON GROWTH MODEL TO DERIVE A JUSTIFIED TRAILING P/E
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0
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(1 )(1 )
($1.60 / $4.00)(1.05) 10.500.09 0.05
Actual P/E = $50.00/$4.00 = 12.50
P b gE r gPE
ISSUES USING THE GORDON GROWTH MODEL
StrengthsSimple and applicable to
stable, mature firms
Can be applied to entire markets
g can be estimated using macro data
Can be applied to firms that repurchase stock
Limitations
Not applicable to non-dividend-paying firms
g must be constant
Stock value is very sensitive to r – g
Most firms have nonconstant growth in dividends
CHOICE OF DISCOUNTED CASH FLOW MODELS
• Rapidly earnings• Heavy reinvestment• Small or no
dividends
Growth
• Earnings growth slows
• Capital reinvestment slows
• FCFE & dividends
Transition • ROE = r
• Earnings & dividends growth matures
• Gordon growth model useful
Maturity
GENERAL TWO-STAGE DDM
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1 1 1
1 1
t nnS S Lt n
t L
D g D g gV
r r r g
EXAMPLE: GENERAL TWO-STAGE DDM
Current dividend = $2.00Growth Current dividend = $2.00Growth for next three years = 15 percentLong-term growth = 4 percentRequired return = 10 percentfor next three years = 15 percentLong-term growth = 4 percentRequired return = 10 percent
EXAMPLE: GENERAL TWO-STAGE DDM
Step 1: Calculate the first three dividends:• D1 = $2.00 x (1.15) = $2.30• D2 = $2.30 x (1.15) = $2.6450• D3 = $2.6450 x (1.15) = $3.0418
Step 2: Calculate the year 4 dividend:• D4 = $3.0418 x (1.04) = $3.1634
Step 3: Calculate the value of the constant growth dividends:• V3 = $3.1634 / (0.10 – 0.04) = $52.7237
EXAMPLE: GENERAL TWO-STAGE DDM
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$2.30 $2.6450 $3.0418 $52.7237V1.10 1.10 1.10 1.10
V $46.17
EXAMPLE: GENERAL TWO-STAGE DDM
• Using the previous example, now we’ll use the trailing P/E to determine the terminal value
• The D4 is $3.1634• Assume also that the projected P/E is 13.0 in year 4 and
that the firm will pay out 60 percent of earnings as dividends
• Year 4 earnings are then $3.1634 / 0.60 = $5.2724• The stock price in year 4 is then $5.2724 × 13 = $68.54
EXAMPLE: GENERAL TWO-STAGE DDM
0 2 3 3
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$2.30 $2.6450 $3.0418 $3.1634 $68.541.10 1.10 1.10 1.10
$55.54
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TWO-STAGE H-MODEL
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L S L
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D g D H g gV
r g
EXAMPLE: TWO-STAGE H-MODEL
Current dividend $3.00gs 20%gL 6%H 5Required return on stock 10%Current stock price $120
EXAMPLE: TWO-STAGE H-MODEL
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$3 1 0.06 $3 5 0.20 0.06
0.10 0.06
$79.50 $52.50 $132.00
L S L
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D g D H g gV
r g
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SOLVING FOR THE REQUIRED RETURN USING THE TWO-STAGE H-MODEL
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01
3 1 0.06 5 0.20 0.06 0.06 10.40%120
L S L LD
r g H g g gP
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EXAMPLE: THREE-STAGE MODEL
• Firm pays a current dividend of $1.00• Growth rate is 20 percent for next two years• Growth then declines over six years to stable rate of 5 percent
• Required return is 10 percent• Current stock price is $50
THREE-STAGE MODEL
Assumes three distinct growth stages:• First stage of growth• Second stage of growth• Stable-growth phase
H-model can be used for last two stages if growth declines linearly
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$1 1.20 $1 1.20
1.10 1.106$1 1.20 0.20 0.05 $1 1.20 1.052
1.10 0.10 0.05 1.10 0.10 0.05
$1.09 $1.19 $10.71 $24.99 $37.98
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THREE-STAGE MODEL EXAMPLE
ESTIMATING THE GROWTH RATE
Industry or Macroeconomic
Average
g = b × ROE• DuPont formula• ROE = r• ROE = industry ROE
THE SUSTAINABLE GROWTH RATE
g b ROE
THE DUPONT MODEL
Net income Total assetsROE = Total assets Shareholders' equity
Net income Sales Total assetsROE = Sales Total assets Shareholders' equity
Net income Dividends Net income Sales Total assetsNet income Sales Total assets Equity
g
EXAMPLE: DUPONT MODEL
Net profit margin 5.00%
Total asset turnover 1.5
Equity multiplier 2.0
Retention ratio 60%
EXAMPLE: DUPONT MODEL
Net income Dividends Net income Sales Total assetsNet income Sales Total assets Equity
0.60 5% 1.5 2.0
9.0%
g
g
g
• Dividend discount models, free cash flow models, residual income models
• Dividend models most appropriate for• Mature, profitable, dividend-paying firms• Noncontrolling shareholder perspective
Choice of Discounted Cash Flow Models
• Assumes constant g and r > g• Applicable to mature, stable firms• Estimated value very sensitive to r – g denominator
Gordon Growth Model
SUMMARY
• Preferred stock valuation where g = 0• PVGO – Value from future growth• Justified leading and trailing P/Es• Implied r and g
Uses of Gordon Growth Model
• Growth• Transition• Maturity
Phases of Growth
SUMMARY
• General two-stage model: growth abruptly declines• H-model: growth gradually declines• Three-stage model: can utilize general or H-model
Multistage Models
• g = Retention ratio × ROE• DuPont analysis:
• ROE = Profit margin × Asset turnover × Equity multiplier
Sustainable Growth Rate
SUMMARY