Investing Basics

Valuing Stocks - Shareholder's Return Requirement, Growth Rate & Dividend Discount Model

This section is similar to the section on valuating bonds. If you recall, a corporation can finance its operations in 2 ways:

1) Issue bonds (debt financing)
2) Issue common or preferred stock shares

We will go on to value these common and preferred stock shares using various dividend growth formulas.

Stocks Valuation Formulas

In order to perform stocks valuation questions, we will be using a combination of these two formulas.

Example 1:

ABC Company has issued $3 of dividends per share for the past several years. Investory's return requirement is 9.5%. Using this given information, what is the current stock price?

Po = D/ Re
Po = 3 / 0.095
Po = $31.58

Example 2:

The current company stock price is $42.70. Dividends into the future are $2.50 / share. What is the shareholder's return requirement?

Po = D / Re
4278 = 2.50 / Re
Re = 2.50 / 42.58
Re = 0.0584 -> 5.84%

Example 3:

ABC company's next dividend is expected to be $4. This dividend is expected to grow at 3% per year. If the investor's return requirement is 9%, what is the current stock price?

Next Dividend = D1 = $4
Growth = g = 0.03
Investor's Return = re = 0.09

Po = D1 / (re - g)
Po = 4 / (0.09 - 0.03)
Po = 4 / 0.06
Po = $66.67