As long as we hold a stock, the only cash flow that we receive is the dividend, that the company pays out of it earnings/net income (the remainder is retained earnings). This method of valuing stocks looks at the value of the stock as the value of the cash flows that we can expect to receive as dividends. Some companies don’t pay dividends and one can has to make significant assumptions about dividends into the future (which clearly have a big impact on the calculated result) – so like all of the methods, it is not always applicable and certainly not without assumptions and disadvantages – but it does take mean looking and thinking about the real expected cash flows and is certainly a method often used and often spoken about.
Duration : 0:4:39
Tags: dividend, earnings, finance, Fischer, funds, investing, investment, market, Michael, money, saving, savingandinvesting.com, savings, stock, valuation
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Oh! I get it now! …
Oh! I get it now! My mistake was confusing required return with expected growth return. Thank you so much! i just couldn’t get my head around how a stock with a higher expected GROWTH rate would be worth less according to the DDM!
Cheers
On the denominator …
On the denominator you have the required rate of return minus dividend growth. The required rate of return is the return that investor’s require to purchase a risky asset (to make it attractive) and is often calculated with the Capital Asset Pricing Model. What your numbers suggest is that a stock that has a 6% required return is worth more than a stock that has an 8% required return (which is more risky). That makes sense. The 8% and 6% are not growth rates. Hope that helps.
Price = Annual …
Price = Annual Dividend divided by (Required rate of Return minus Expected Dividend Growth)
So a common share yielding a $2 annual dividend, with expected annual growth @ 8%, and a dividend growth of 3%, has a value of $40 according to the DDM.
What I’m having trouble with is understanding the donominator figures. Lower denominator = Higher stock price…so a lower required rate of return is better??? It doesn’t make sense!
Same stock @ 6% growth (2% less!) is worth $67! Huh???
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