DIVIDEND VALUATION MODEL

Compiled By:
BAJI VAJIHUDDIN FAIZ MIRZA HARSH SAINI BUSHRA KHAN HIMANSHU DATT FARAZ KHAN LEJO JOSEPH

TOPICS TO BE COVERED
Introduction

Zero growth model

Two stage growth model H model Limitations

DIVIDEND VALUATION MODEL

Dividend valuation model was given by

Myron.J.gordon in the year 1959 this model is also called Gordon Growth model Dividend valuation model is a way of valuing a company based on the theory that a stock value is worth the discounted sum of all its future dividends payments It is used to value stocks based on Net present value of its future dividends

 Equation:
P = D1

rg Where : P is the value of current stock G is the constant growth rate D1 is the next year (future) dividend R is the constant discounting factor or cost of equity for that company

 If suppose Xyz ltd expect dividend per share on equity is Rs

2 and dividend per share has grown over the past future year at a rate of 5% and rate of return is 15% then its price of the stock would be valued as P = 2 = Rs 20 0.15-0.05

 When the dividends and growth are rising,

declining , or randomly fluctuating then this model can be furthur explained as Zero growth model Two stage growth model H-model

Zero growth model

The dividend per share remains constant forever

and the growth rate is nil (zero) P = D r

Two stage growth model

This is the simplest extension of constant growth

model (Gordon model) assumes that the extra ordinary growth (good or bad) will continue for finite number of years and thereafter the normal growth rate will prevail indefinitely

H-model
When the dividend per share , currently growing at an

above normal rate and rate of growth is normally declining for a while , thereafter it grows at a constant normal rate It is based on following assumption

 The H-model is used to value a stock when

it is assumed that the dividend growth will change from one growth rate to another in a linear manner. Let ga represent the abnormal growth and let gn represent the normal growth. Using the H-model, the growth rate will change from ga to gn over a period of years, 2H. If the period in which this transition takes place is 2H, the half-life of this transition is H. The formula is as follows: growth abnormal from normal value Added from value

Limitations
The presumption of a steady and perpetual

growth rate less than the cost of capital may not be reasonable. The stock price resulting from the Gordon model is hyper-sensitive to the growth rate chosen. The focus on dividends in this model can lead to skewed estimates of value for the firms that are not paying out what they can afford in dividends. It will be under estimate the value of the firm that accumulate cash and pay out less dividends.