# Equity Valuation: Dividend Discount Models

**Topics:**Generally Accepted Accounting Principles, Asset, Balance sheet

**Pages:**40 (3073 words)

**Published:**September 19, 2015

Lecture Map

Definitions of Value

Book value, Liquidation value, Intrinsic value, Market value

Dividend discount models

Constant-growth

Multi-stage growth

Value Metrics and Determinants of Value

Current earnings and growth

P/E

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1

Book Value of Equity

The firm’s equity value, or stock value, is

stated right on the firm’s books

This is NOT the market value of equity

Book value per share of Equity is the

value of common equity on the books,

divided by the number of shares

The value of Stockholder’s equity is in the

section of the balance sheet called Liabilities

and Owners’ Equity

Refer to the last set of pages for the Income

Statement, Balance Sheet, and CF Statement

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2

Book Stockholder’s Equity

Derived from accounting rules

Simply the amount by which total assets exceed total

liabilities, where total assets are generally valued at purchase price less depreciation

Some questions about the assets on the Balance Sheet?

Where is the

Where is the

property?

Where is the

employees?

Where is the

suppliers?

PV of the firm’s current projects?

value of the firm’s patents and other intellectual

value of the firm’s knowledge base, stored in its

value of the firm’s relationships with buyers and

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3

Let’s check some numbers:

Assuming a price of $76.56 for Walmart as of September 4, 2014

Book Value of Equity?

Price to Book?

Price to Sales?

Price-to-EPS (P/E)?

Debt-to-Equity?

Return on Equity (ROE)?

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4

Liquidation Value

The amount the firm could be sold for – either in

pieces (sell off divisions or business lines) or as a

whole.

Liquidation value can also mean the value of the actual

assets of the firm, assuming we just shut down the

business and sell the assets (this is a real floor on

value).

Question: In general, can you buy a firm for less

than its liquidation value?

Can a firm be worth less than its book value?

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5

Equity Valuation –

Intrinsic Value

Intrinsic Value is the present value of the

expected future net cash flows of the firm,

discounted at the risk adjusted required

rate of return

Can intrinsic value be different from

market value?

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6

Dividend Discount Models

Dividend Discount Models are an attempt

to operationalize the intrinsic value rule

Dividends are defined as the net cash flows

flowing to the owners of the firm

Net of costs, including operating costs and any costs

of debt (interest payments)

The value of the stock is the present value

of all expected future dividends that flow

to the stock owner

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Dividend Discount Model –

Constant Growth Assumption

Assume dividends today are equal to D0

Assume dividends are going to grow at a constant rate g

per year forever

Let k equal the discount rate

Then price, or value V, today can be found as

D0 (1 g ) D0 (1 g ) 2 D0 (1 g )3

V0

.....

2

3

(1 k )

(1 k )

(1 k )

simplifies to

D0 (1 g )

D1

V0

[Gordon Growth M odel]

kg

kg

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Dividend Discount Model –

Value Implications

D0 (1 g )

D1

Value Today V0

kg

kg

What happens when g changes?

g=0?

What happens when k changes?

What happens if g > k?

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9

Dividend Growth Model –

Re-arranging the equation

D1

D1

V0

k

g

kg

V0

Today’s stock price (V0) is easy to find

Next year’s dividend is relatively easy to estimate

Last few years’ dividend is easy to find

You can use this data to find g and project next year’s D1 Or, analysts put out growth forecasts

The firm puts out growth forecasts

This approach to estimating k, the market required rate

of return on the stock, is used in...

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