Stock Valuation With Non-Constant Dividends (Using Excel)

Summary

In this video, you'll learn how to apply the Dividend Discount Model (DDM) to value a stock with nonconstant dividends. The example demonstrates how to handle fluctuating dividends over the first four years, followed by a constant 4% growth rate. By using the Gordon Growth Model for year 4 onwards, and discounting all future dividends and the stock price at year 4 back to present value using NPV, the video shows step-by-step how to determine the stock’s worth today at a 12% required rate of return. This approach is ideal for stocks with changing dividend patterns before settling into constant growth.

Takeaways

• 😀 Use the Dividend Discount Model (DDM) to calculate stock price when dividends are nonconstant, but eventually follow a constant growth pattern.
• 😀 Start by forecasting dividends for the first few years, which may be nonconstant, before applying a constant growth rate after a certain time.
• 😀 In this example, the dividends for the first four years are expected to be $17, $13, $11, and $6.50 respectively.
• 😀 After year four, the dividends are expected to grow at a constant rate of 4% annually.
• 😀 Apply the Gordon Growth Model to determine the stock price at the end of year 4, using the expected dividend for year 5 and the required rate of return.
• 😀 The Gordon Growth Model formula is: Stock Price = Dividend at Year 5 / (Required Return - Growth Rate).
• 😀 In this case, the price of the stock at the end of year 4 is calculated as $84.50 based on the year 5 dividend and the 12% required rate of return with a 4% growth rate.
• 😀 Discount the expected dividends for the first four years and the calculated stock price at the end of year 4 to the present using Excel’s NPV function.
• 😀 The final stock price today (at time 0) is determined by adding the discounted values of the dividends and the year 4 stock price.
• 😀 The calculated stock price today in this example is approximately $912, which reflects the present value of both the nonconstant and constant dividend growth periods.
• 😀 This approach is useful for valuing stocks with irregular dividend patterns followed by steady growth, helping investors make informed investment decisions.

Q & A

What is the Dividend Discount Model (DDM) used for?

The Dividend Discount Model (DDM) is used for stock valuation by calculating the present value of a company's future dividends, discounted back to the present time based on a required rate of return.

What does it mean for a stock to have nonconstant dividends?

Nonconstant dividends refer to a situation where the dividends paid by a company do not follow a fixed or predictable pattern, and they can fluctuate over time. In the case discussed in the script, dividends decrease for the first few years before transitioning to a constant growth rate.

How is the stock price calculated at the end of year 4 in this example?

At the end of year 4, the stock price is calculated using the Gordon Growth Model, which assumes constant dividend growth from year 5 onward. The formula is: P4 = D5 / (r - g), where D5 is the dividend in year 5, r is the required rate of return, and g is the growth rate.

Why does the calculation use the value of $6.76 at the end of year 4?

The value of $6.76 at the end of year 4 is calculated by multiplying the dividend at the end of year 4 ($6.50) by the growth factor (1.04), which accounts for the 4% growth rate starting from year 5.

How do you discount the future dividends back to the present?

To discount the future dividends back to the present, you use the NPV (Net Present Value) formula, which applies the required rate of return to calculate the present value of each dividend payment. The formula is: NPV = D1 / (1 + r)^1 + D2 / (1 + r)^2 + ... + Dn / (1 + r)^n.

Why is the stock price at the end of year 4 ($84.50) important in this example?

The stock price at the end of year 4 ($84.50) represents the present value of all future dividends starting from year 5 onward, which grow at a constant rate of 4%. This value is important because it is added to the dividends from the first four years when calculating the total stock price today.

What does the required rate of return of 12% represent in this calculation?

The required rate of return of 12% represents the investor's expected return on the stock, which is used to discount future dividend payments and the stock price at the end of year 4 back to present value.

How do you calculate the stock price today after considering all dividends and the stock price at year 4?

To calculate the stock price today, you sum the discounted values of each dividend payment (from years 1 to 4) and the discounted stock price at the end of year 4 ($84.50). The formula for NPV is used to discount each value, and the total gives the stock price today.

What happens to the dividends after year 4 in this example?

After year 4, the dividends are assumed to grow at a constant rate of 4% each year, starting with a dividend of $6.76 in year 5, which is 4% higher than the year 4 dividend of $6.50.

What does the final stock price of $912 represent?

The final stock price of $912 represents the present value of all expected dividends from years 1 to 4, plus the discounted stock price at the end of year 4 ($84.50), calculated using the 12% required rate of return.