Further Insights Into The Gorden Dividend Discount Model (DDM)

In a previous post, Gordon Dividend Discount Model (DDM) versus FCF Valuation Model, I explored the relationship between dividends being paid versus net income being retained, and how these both balance out within the DDM so that if more dividends are paid, less growth occurs, and if more net income is retained (i.e., less dividends are paid), more growth occurs.

A discussion of such is necessary because with the DDM equation below, the question quickly arises regarding the dividend being paid out versus the net income being retained:

Limit Continue reading “Further Insights Into The Gorden Dividend Discount Model (DDM)”

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The Proper Use of Beta (β)

In my previous post I highlighted the flaws associated with Beta (β), in this post I would like to explore the proper use of Beta.

Studies have shown that managed portfolios only outperform the S&P500 Index about 1/3rd of the time in both bear and bull markets – this means that for 2/3rds of the time it is better to just invest your money in an index fund, and forget about it.  So how do we get in this upper 1/3rd that beats the market index?  One potential way is the proper use of Beta.

If Beta, when applied to the CAPM, gives us the required return assuming a well diversified portfolio (based on historic data), then we must earn above this required return in order to justify investing in an individual stock versus the market index.  This means that we must determine what our expected (anticipated) return is for the stock in question.

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What is an Incremental Investment Dollar Worth?

Whether you are an employee, a business owner, or a shareholder, you may have wondered what an incremental dollar of investment is worth to your company.

First it depends upon the cost of funding (F%) for an incremental dollar of investment ($I), and second the return (R%) that you earn on that incremental dollar of investment.  The dollar value ($V) created by the dollar of investment is simply $V = $I*(R% – F%), and the return (RI%) on the dollar of investment is RI% = R% – F%.

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PEG – Price/Earnings to Growth Ratio

The PEG ratio is another way to try and identify undervalued high growth stocks through a technical screen.  It should not be used alone to select stocks, and should instead be complemented with a fundamental analysis of the market and company including a detailed discounted FCF model to value the stock properly.

In a previous post Valuation Multiples Post I detailed the P/E ratio and PEG ratio, and defined them by the following two equations:

 

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Gordon Dividend Discount Model (DDM) versus FCF Valuation Model

Two popular models for valuing equity are the DDM and FCFS models.  The DDM is sometimes referred to the Gordon constant growth model, because it assumes the firm is growing at constant growth rate.  Both of these models are perpetuities of cash flows that have been paid to the shareholder (i.e., D0) or cash flows that are available to be paid to the shareholder (i.e., FCFS0).  So not only do both models rely on constant growth, but also constant growth to infinity.  Some may question the reality of a firm ongoing to infinity, but consider that after about 30 years, the cash flows are near zero due to discounting, and a firm paying dividends for 30 years is very plausible. Continue reading “Gordon Dividend Discount Model (DDM) versus FCF Valuation Model”

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