Equity Valuation: Discounted Dividend Valuation

Question 1

When is DDM Suitable?

Answer 1

1. Company is dividend paying
2. Board has established div policy that is clear and related to profitability
3. Investor is not taking control

Question 2

DDM Formula for Single Period

DDM Formula for Multi Periods

Answer 2

Single: Vo = D1/(1+r)^1 + P1/(1+r)^1 Or Vo = D1+P1 / (1+r)^1

Multi: Vo = D1/(1+r)^1 + … (Dn+Pn)/(1+r)^n

r: required rate of return on the stock

Question 3

DDM GGM Equation

Answer 3

Vo = D1 / (r-G)

D1 = Do(1+G)

Question 4

Using GGM to Forecast Dividend in n-Period

Answer 4

Dt = Do(1+G)^t

• Do = Most recent dividend*
• t = The number of the future period*

Question 5

GGM with Negative Growth Rate

Answer 5

Vo = D1/r-(-G)

- This means the denominator will grow (stock value will fall)

Question 6

Vo based on PVoGO

Answer 6

Vo = E1/r + PVGO

• E1: All earnings of a no-growth company are distributed*
• E1/r: Value of no growth company*
• PVGO: Present Value of Growth Opportunities*

Question 7

Solving for PVoGO

Answer 7

MrktP = EPS/r + PVoGO

- Use EPS to solve for no-growth and use PVoGO as the variable.

Question 8

Leading Price to Earnings Ratio / Expressed with GGM

Answer 8

Po / E1 or (D1/E1) / (r-G) or (D1/r-G) / E1

E1: EPS

Question 9

Lagging Price to Earnings Ratio / Expressed with GGM

Answer 9

Po / Eo **or ** [Do(1+G)/Eo] / r-G or (D1/r-G) / Eo

Question 10

Two Stage DDM Model

Answer 10

Vo = {∑[Do(1+Gs)^t] / (1+r)^t} + {[Do(1+Gs)^n(1+Gl)] / [(1+r)^n(r-Gl)]}

• Gs = growth rate in first period*
• Gl= growth rate in second period*

Question 11

H-DDM Model (high growth model)

Answer 11

Vo = [Do(1+Gl) + DoH(Gs-Gl)] / r-Gl

• H = Half-life of the high growth rate period*
• Gl = Normal Dividend Growth rate after year H*
• Gs = Initial short term dividend growth rate*

Question 12

Sustainable growth rate

Answer 12

G = b X ROE

b = retention rate