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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.

QUESTIONS

1. Use the Internet to access financial sites to find a company that does not pay dividends.

2. 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.

3. Then, compare and contrast how these variables affect the valuation of a dividend paying stock and a non-dividend paying stock.

Solution Preview

1. Use the Internet to access financial sites to find a company that does not pay dividends.

We use google as an example of a company that does not pay dividend (http://finance.yahoo.com/q?s=GOOG). Likely most tech companies, Google pays no dividend to its shareholders.

2. 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.

-It should be noted that practitioners rarely use the DDM (in fact almost never). The DDM is an academic concept only and is taught in classrooms and used by students

-The reason for this is because DDM does a poor job forecasting actual stock prices.

-Here, we note that we can generally divide companies into two types, growing companies (this includes most new listed companies such as tech companies like facebook, google, etc. Companies in this category usually have shorter history) and stable companies (these are the companies with longer history, such as banks, CPG companies, auto makers etc.).

-In the beginning stages, a company MUST reinvest its earnings for the companies growth (e.g. ...

Solution Summary

The dividend and non-dividend stock valuations are provided. The investments in the form of dividends are determined.

$2.19