Dividend and Non-Dividend Stock Valuation
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The writer will have to pay attention to grammatical errors when completing this papers. APA is critical and the writer will have to clearly respond to all the items in the questions clearly in two page word document. I have included some resources for the writer to use where necessary. The writer must elaborates on all explanations and must clearly demonstrate proper understanding of the subject matter.
Dividend and Non-Dividend Stock Valuation
One primary reason individuals invest in stocks is to receive returns on their investment in the form of dividends. Not all companies opt to offer dividends to their investors, however. In their article The Dividend Discount Model in the Long-Run: A Clinical Study, the authors discuss the importance of three variables that affect the valuation of a dividend and non-dividend paying stocks. They note how valuation is influenced by the size, timing, and uncertainty of cash flows that the asset will generate for investors over its lifetime.
Use the Internet to access financial sites to find a company that does not pay dividends.
From a theoretical view, explain the merits and/or pitfalls of using the dividend growth model to estimate the stock price of a non-dividend paying stock.
Then, compare and contrast how these variables affect the valuation of a dividend paying stock and a non-dividend paying stock.
Resources.
• Article
• Foerster, S., & Sapp, S. (2005). The dividend discount model in the long-run: A clinical study. Journal of Applied Finance, 5(2), 55–75. Retrieved from Business Source Premier database.
In this study, the authors research over 100 years of historical information on one company to determine the actual share price of stocks and then compared this with the expected price, determined using dividend discount models. They find that the models accurately predict the share prices, much more so than other financial methods.
• Cardinale, M. (2007). Corporate pension funding and credit spreads. Financial Analysts Journal, 63(5), 82–101. Retrieved from Business Source Premier database.
This study explores the relationship between pension funding and corporate financial policy and how they affect stock market valuation.
• Cai, N., & Jiang, X. (2008). Corporate bond returns and volatility. Financial Review, 43(1), 1–26. Retrieved from Business Source Premier database.
After studying 10 years of corporate bond excess return volatility, the authors conclude that there is a direct relationship between volatility and idiosyncratic risk as significant predictors of corporate bond excess returns.
• Bali, T., Demirtas, K., & Tehranian, H. (2008). Aggregate earnings, firm-level earnings, and expected stock returns. Journal of Financial & Quantitative Analysis, 43(3), 657–684. Retrieved from Business Source Premier database.
In performing an analysis of methods for establishing expected stock returns, the authors conclude that earnings yield have the best explanatory power.
• Bulan, L., Subramanian, N., & Tanlu, L. (2007). On the timing of dividend initiations. Financial Management (Blackwell Publishing Limited), 36(4), 31–65. Retrieved from Business Source Premier database.
After studying the timing and significance of dividend initiations in the lifecycle of a firm, the authors conclude that certain characteristics can be used to explain the reasoning behind the timing.
• Bosch, M., Montllor-Serrats, J., & Tarrazon, M. (2007). NPV as a function of the IRR: The value drivers of investment projects. Journal of Applied Finance, 17(2), 41–45. Retrieved from Business Source Premier database.
SAMPLE ANSWER
Introduction
Dividend Growth Model is one of the fundamental concepts for analyzing and determining the average value of a company’s stock. It’s also referred to as Gordon Model. It’s utilized as a strategy for estimating investments that are based on the actual gains that have been pegged on the dividend yield. The growth model estimates the value of stock based on the current payment of dividends and the general pattern of payment of dividends over the years by the company.
One of the companies that currently don’t pay dividends is Gilead Sciences (GLD) and is one of the companies 500 SP companies.
Companies that have good dividend yields together with reasonable and better payout ratios are mostly considered safe and reliable investments that also have good income and offer better opportunities for capital growth. Generally, the dividend growth model indicates the past performance of a company. To calculate the growth model, the current dividend payout and the dividend growth rate together with the required or expected rate of return are utilized to arrive at the growth model (Brav, Graham, Harvey & Michaely, 2004).
The conventional standards are that the DDM (Dividend Discount Model) cannot be utilized to value a company’s stock that either pays very low dividends or no dividends at all. This concept is wrong; the dividend payout ratio should be adjusted to accurately reflect the changes that are expected from the growth rate. A fairly reasonable value for the firm can be thus obtained even for firms that don’t pay dividends. A company that has a high growth rate and which is not paying any dividends currently can still be rated and valued based on the expected dividend payout when the growth rate reduces or declines. But if the company’s payout ratio is not accurately adjusted or not adjusted at all to reflect the current changes in the rate of growth then the DDM will underestimate the total value of the non-dividend paying company stocks or the low-dividend company stocks paying (Bulan, Subramanian & Tanlu, 2007).
The DDM is mostly criticized on the grounds that it’s too conservative when estimating values. This notion stems from the results that are based on the value that has been determined by another value that’s more than actual present value of the expected dividends (Bosch, Montllor-Serrats & Tarrazon, 2007). For example, its mostly argued that the DDM on average does not represent the values of unutilized assets. There is no justification whatsoever that the unutilized assets cannot practically be valued separately and later added to the DDM value. However, some of the ignored assets by the DDM like brand names and their values can for all be accommodated within the models context. The model does not incorporate ways of compensating stockholders in cases of buybacks. The new version of the DDM has however countered this argument or inadequacy.
Finally, the DDM model is considered contrarian. As the market for stock increases, less stock will be undervalued using the DDM approach. This argument is not entirely true. If the stock market improves or grows its largely because of the market’s fundamentals such economic growth in the country or may be due to reduced interest rates which means that the stock values may also follow the same trend. However, if the growth trend is not due to the economic fundamentals, then the DDM would also not follow the trend, in brief, the reactions of the values of the DDM represent positions of strength and not weaknesses for the model. The model may be signaling that stock market has been overvalued in relation to the cash flows and dividends hence a cautious investor will follow the cue. The DDM provides very impressive results eventually in the long term (Foerster & Sapp, 2005).
References
Brav, A., Graham, J.R., Harvey, C.R. and Michaely, R. (2004) Payout Policy in 21st Century Working Papers, Duke University, Durham, NC.
Bosch, M., Montllor-Serrats, J., & Tarrazon, M. (2007). NPV as a function of the IRR: The value drivers of investment projects. Journal of Applied Finance, 17(2), 41–45. Retrieved from Business
Bulan, L., Subramanian, N., & Tanlu, L. (2007). On the timing of dividend initiations. Financial Management (Blackwell Publishing Limited), 36(4), 31–65. Retrieved from Business Source Premier database.
Foerster, S., & Sapp, S. (2005). The dividend discount model in the long-run: A clinical study. Journal of Applied Finance, 5(2), 55–75. Retrieved from Business Source Premier Database.
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