Security Analysis Topic: Group 6D

Topic: The dividend valuation method sounds logical in valuing shares. However, it is not free
from limitations. Discuss its major features and critically assess the empirical accuracy of the
model.
Achilleas Manousakis
Dichao Cao
Kyriakos Leotsarakos

Presantation
Definition and Characteritstics
Empirical Data
Empirical Data

Xinyu Zhang
Wang Yi

Limitations

Gordons Dividend Discount Model

Sources of income for shareholders:
1.Capital gains
2.Dividends
Definition: The theory that the stock price is worth
the sum of all of its future dividend payments,
discounted back to their present value.
Named by Myron J. Gordon (1956)

Constant Growth Model

where

P= Price of the security

D= Dividend at time t

r=Equity cost of capital

G=Expected dividend growth rate

In General an investor buys when and sells when

Example:
Consider a company that pays annual dividends of $2. With an equity cost of capital of 10% and expected dividend growth of 6,7,10 and 11%,

A. ==50

, g=0.06

B.

==66.67

, g=0.07

C.

==?

D.

==-200

, g=0.1
, g=0.11

Limitations-Assessment
The dividends are very difficult to predict=>Some companies chose
not to
Its difficult to predict their growth rate.
A small difference in the growth forecast can lead to large changes
in the estimated stock price
Dividends are taxed based on the year they are incurred. Capital
appreciation is not taxed until it is realized as a capital gain.
What happens when r < =g? (multi stage growth model)

Empirical Data

Source: The Dividend Discount Model in the Long-Run: A Clinical Study, Stephen R. Foerster and Stephen G. Sapp, Richard Ivey School of
Business,2005

Empirical Data (2)

o There is no large scale recent research

o Many different markets
o Narrow Focused usually on blue chip companies
o Other studies suggest that here are other methods better predicting a stocks price
o From the 90s the DDM doesnt the share price very well
o More Research is needed

Conclusion
The Model:
1. Is by no means perfect
2. Is based on many assumptions about the companies
3. Should be better used in steady reliable types of stocks e.g. utilities
4. It is not very valuable for growth companies
5. Its value is derived from its simplicity
6. In general it should be combined with other valuation methods

Bibliography
1. Investigation and Comparison of Ohlson, Model, Economic Value Added Model and Dividend Discount
Model in 50 Top Companies in Tehran Stock Exchange, Farhad Hanifi, Mansoureh Aligholi, Kourosh
Asayesh, 2014
2. The Dividend Discount Model in the Long-Run: A Clinical Study, Stephen R. Foerster and Stephen G.
Sapp, Richard Ivey School of Business,2005
3. Stock Price Valuation: A Case study in Dividend Discount models & Free Cash Flow to Equity models
(Master Thesis), Anders Karlsson Niklas Josefsson, 2011
4. An Empirical Test of the Accounting Based Residual Income Model and the Traditional Dividend Discount
Model, Xiaoquan Jiang , BonSoo Lee, The Journal of Business, Vol. 78, No. 4 (July 2005), pp. 1465-1504
5. Stock prices and the dividend discount model: did their relation break down in the 1990s?, Alireza
Nasseh ,Jack Strauss, The Quarterly Review of Economics and Finance 44 (2004) 191207
6. The Dividend Discount Model: A Primer, by James L. Farrell, Jr., Financial Analysts Journal, Vol. 41, No.
6 (Nov. - Dec., 1985), pp. 16-19+22-25
7. Investment, Bodie, z., Kane, A., Marcus, A., 2011, 9 th Edition.
8. Corporate Finance, Berk, Demarzo, Third Edition, 2014

Thank you!