Equity Valuation: Dividend Discount Models

Topics: Generally Accepted Accounting Principles, Asset, Balance sheet Pages: 40 (3073 words) Published: September 19, 2015
Equity Valuation


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

Lesmond

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


Lesmond

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

Lesmond

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)?

Lesmond

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?
Lesmond

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?

Lesmond

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

Lesmond

7

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]
kg
kg
Lesmond

8

Dividend Discount Model –
Value Implications
D0 (1  g )
D1
Value Today  V0 

kg
kg


What happens when g changes?





g=0?

What happens when k changes?
What happens if g > k?
Lesmond

9

Dividend Growth Model –
Re-arranging the equation
D1
D1
V0 
k 
g
kg
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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