Investing Basics

Valuating Stocks - Dividend Growth Model Timelines

Here is some data about a hypothetical ABC Company:

- Next planned dividend is $4 per share.
- Growth rate of the bond is projected to be at 15% for the next 3 years and thereafter a constant growth of 5%
- Required Rate of Return is 18%
- With the above data, calculate the current stock price?

A financial timeline will be useful in calculating a question like this:

|0__________|1_________|2_________|3________|4_________|5________|

Growth of Dividends

Since the growth rate of the dividends is 15% from Years 1-4 and 5% in Year 5, we perform these calculations:

D1 = $4
D2 = ($4 x 1.15) = $4.6
D3 = ($4.6 x 1.15) = $5.29
D4 = ($5.29 x 1.15) = $6.08
D5 = ($6.08 x 1.05) = $6.39

Dividend Growth Graph

Here's a graphical representation of the Dividend Growth:

Step 1:

Using the dividend of Year 5, we calculate the stock price in Year 4 which is also "P4."

P4 = D5 / (re - g)
P4 = 6.39 / (0.18 - 0.05)
P4 = 6.39 / 0.13
P4 = $49.15

Step 2:

Using your Financial Analyst BAII Plus Calculator, we use the Cash Flow button:

2nd -> CF

CFO = 0
CO1 = 4
CO2 = 4.6
CO3 = 5.29
CO4 = 6.39 + 49.15 = 55.23
I = 18%, NPV = ?
Solution: NPV = $38.40 (which is our current stock price).