Decomposing the Dividend Discount Model

The DDM assumes that the theoretical value of a company's stock (P) can be obtained by summing the present values of all future dividend pay-ments.63 The standard DDM price formula is P d (k - g) (see Table 4.11 for symbol definitions). In the absence of growth (that is, with g equal to zero), the fixed annual earnings are paid out as dividends. Price P is simply the value of a perpetual annuity discounted at a nominal market rate (k). More generally, when g is greater than zero, the investor's...

Retirement Planning and the Asset Salary Ratio

We are grateful to Gary Selnow, John Ameriks, Mark Warshawsky, Harry Klaristenfeld, Deanne Shallcross, Yuewu Xu, and anonymous readers for helpful comments and suggestions. 1. FASB 87 requires private pension plan sponsors to report their surplus, or the excess of assets over present-value liabilities, on a market-to-market basis. GASB 5, on the other hand, does not require public pension plans to measure liabilities with a discount rate that reflects current market conditions. 2. At that time,...

References

Common Sense on Mutual Funds. New York John Wiley & Sons. Damodaran, Aswath. 1994. Damodaran on Valuation. New York John Wiley & Sons. Estep, Tony. 1987. Security Analysis and Stock Selection Turning Financial Information into Return Forecasts. Financial Analysts Journal, vol. 43, no. 4 (July August) 34-43. Fairfield, Patricia M. 1994. P E, P B and the Present Value of Future Dividends. Financial Analysts Journal, vol. 50, no. 4 (July August) 23-31. Ferguson, Robert....

The Levered PE Ratio

A vast literature examines the role of debt in corporate valuation, but most of these works proceed from the vantage point of corporate finance (i.e., ascertaining the effects of adding debt to a previously unlevered company). The investment analyst, however, confronts an already-levered company with already-levered return parameters. The analyst's challenge is to estimate the stock's theoretical value by inferring the company's underlying structure of returns. This shift in vantage point leads...

The Salesdriven Franchise Model

In many situations, the impetus for new strategic initiatives arises from the prospect of an exceptional sales opportunity. If these opportunities truly add economic value, then the capital investment involved in their pursuit should naturally lead to a correspondingly high ROE. Because the sales potential itself is the fundamental source of these corporate initiatives, it is generally more natural to use a sales-driven framework to estimate their effect on the firm's profitability, growth, and...

The Perpetual Equivalent Return

In the standard dividend discount model, all new investments are assumed to provide the same return in perpetuity. This perpetual-return model allowed the development in The Franchise Factor of a simple formula for the exact franchise factor. In a certain sense, the perpetual-return model turns out to be general, because any pattern of payments can be converted to an equivalent perpetual return see Appendix 4B . An exact franchise factor can be computed for any return pattern by using the...

Generalization To Other Financial Applications See Chapter

Chapter 11 represents an attempt to show that the same decomposition used in the franchise value can be generalized to model a number of financial situations. The subject of this chapter is a defined contribution DC retirement plan. The investor specifies his or her objective as achieving a retirement annuity that pays a prescribed percentage of his or her final salary. The objective is to find the current asset salary ratio required to keep the plan on track, given values for salary growth,...

Price Ratios

The preceding development focused primarily on the direct estimation of a firm's intrinsic value. In practice, however, many if not most analytical procedures are conducted on the basis of one or more comparative ratios. The field of financial analysis uses ratios of all types from price earnings to innumerable accounting measures. This almost compulsive drive for rationizing is motivated by several objectives. First is the understandable desire to achieve some relative comparability by...