Sunday, 27 May 2012

Stock valuation: Two-stage Dividend Growth Model (Critical Review)


By Jackie, Researcher
Topic: Education
Area of discussion: Finance
Chapter: Valuation of Assets and Company (Stock valuation model)



The objective of this week’s research is to compare which method is more accurate, faster and consumes lesser time by comparing the table method and the formula method to calculate the two-stage dividend growth model. Step by step tutorial is provided below with clear explanation and workings.



Introduction
Ideally, many companies will usually experience above normal growth rates for a short period of time before settling in on a lower but stable perpetual growth rate. Thus, it would be inappropriate to calculate the stock’s intrinsic value based on the single-stage dividend growth model. Unlike single-stage dividend growth model, the two-stage dividend growth model formula is often not provided in exam.



Sample question
Compute the value of a share of common stock of a company whose most recent dividend was $2.50 and is expected to grow at 3 percent per year for the next 5 years, after which the dividend growth rate will increase to 6 percent per year indefinitely. Assume 10 percent required rate of return.






Therefore, by using the formula method, we can actually save a lot of time (especially during examinations as the time is limited). Besides, it is also more accurate as it minimizes the rounding effect as compared to the table method. Moreover, we can compute it much faster as we do not need to refer to Future Value Interest Factor (FVIF) table as well as Present Value Interest Factor (PVIF) table.


The table is available here for
Future Value Interest Factor (FVIF): http://arjun.net.np/calculators/fvif_table.php
Present Value Interest Factor (PVIF): http://arjun.net.np/calculators/pvif_table.php?beg=0


Notes:
The question above is extracted from Principles of Corporate II – FIN326, Session: May 2010, Tutorial 3 at Mr.Lim’s class in INTI College Subang Jaya, Malaysia.


Related links and additional readings:


Dividend growth models

Why a stock valuation process is important in Dividend Growth Model?

Dividend discount model – stock valuation – formula – how to calculate –Subjectmoney.com


4 comments:

  1. aku tidak paham apa yang saudara katakan,kalau boleh saran siapkan translate untuk blog ini my freend

    ReplyDelete
  2. We believe dividend payments are a good way to reward long term investors and we hope policy makers will take steps to change tax policy rather than punishing long term investors.

    ex dividend calendar Australia

    ReplyDelete
  3. I truly enjoyed reading it, you will certainly be a really good author.Steer clear of guarantee that I bookmark your website and will come back in the future.
    Profit

    ReplyDelete
  4. Another alternative to consider might be to use a Free Cash Flow model instead of of a dividend growth model. Especially if a company has a lot of good internal investment projects, the money will be reinvested rather paid out in dividends.

    ReplyDelete