R.29 Discounted Dividend Valuation/models (DDM)

Question 1

DDM

Dividend Discount Models

• Generic DDM
• Single HP
• n years HP
• GGM
• Expected HPR
• Two Stage DDM
• Zero g Model
• H-Model
• PV of Growth Opportunities (PVGO)

Answer 1

Question 2

DDM

Commentary on DCF/DDM

• GGM strengths/limitations
• 2-stage model challenges w/ constant growth both stages
• Improvement built into H-Model
• Rationale for 3-stage model
• Spreadsheet approach

Answer 2

Question 3

DDM

• Multi-stage models (strengths/limitations)
• Sustainable Growth Rate (formula, meaning)
• ROE estimation (5-stage formula)

Answer 3

Question 4

• GGM and P/E Ratios
• Required rate of return using GGM

Answer 4

Question 5

• 2-stage DDM
• H-model
• Required return for GGM with H-Model

Answer 5

Question 6

• Sustainable G
• ROE

Answer 6

Question 7

Discounted Cash Flow methods and appropriate scenarios

1. Divididend Discount model (DDM)
2. Free Cash Flow models (FCF)
3. Residual Income models (RI)

Answer 7

Dividend Discount model (DDM) defines cash flow as dividends to be received in the future. This is based on the idea that, over rime, earnings and dividends will converge. The DDM is most appropriate for mature and profitable
firms chat are not engaged in a fast-growing segment of the economy, or for large, diversified portfolios like the S&P 500.

Use DDM when:

• The firm has a dividend history.
• The dividend policy is consistent and related to earnings.
• The perspective is that of a minority shareholder.

Free Cash Flow models (FCF) Two versions of FCF valuation exist: FCF to the firm (FCFF), and FCF to equity (FCFE).

Use FCF when:

• Firm doesn’t have stable dividend policy.
• Firm has dividend policy that’s not related to earning.
• Firm’s FCF is related to profitability
• Perspective is that of a controlling shareholder.

Residual Income models (RI) refers to amount of earnings during
period that exceed the investor’s required earnings. Think of as economic profit. In this framework, the value of the firm’s equity is the firm’s book value
plus the present value of all future residual income. The RI method can be difficult
to apply because it requires an in-depth analysis of the firm’s accounting accruals.

Use RI when:

• Firm doesn’t have a dividend history.
• Firm’s FCF is negative.
• Firm with transparent and high quality accounting.

Question 8

PVGO

H-Model

Answer 8