EVALUATING STOCKS THAT DONT PAY DIVIDENDS

The discounted dividend assumes that

the firm is currently playing a
dividend. However many firms even
highly profitable ones. Including
googles, deil and apple have never
paid a dividends in the future, we can
modify the equations presented in the
chapter and use them to determine
the value of the stocks.
A new business often expects to
have low sales during its first few
years of operation as it develops its
product. Then if the product catches
on sales will grow rapidly for several
years, Sales growth brings with It the
need for additional assets- a firm
cannot increase sales without also
increasing its assets and asset growth
requires an increase in liability and
equity accounts. Small firms can
generally obtain some bank credit, but
they must maintain a reasonable
balance between debt and equity.
Thus, additional bank borrowings
require increase in equity and getting
the equity capital needed to support
growth can be difficult for small firms.
They have limited access to the
capital markets and even when they
can sell common stocks, their owners
are reluctant to do so far fear of losing
voting controls. Therefore, the best
source of equity for most small
business is retained earnings; for this

reason most small firms pay no

dividends during their rapid growth
years. Eventually, though, successful
small firms do pay dividends and
those dividends generally grow rapidly
at first but slow down to a substitute
constant rate once the firm reaches
maturity.
If a firm currently pays no dividends
but is expected to pay future
dividends, the value of its stock can be
found as follows:
1. Estimate at what point
dividends will be paid the
amount of the first dividend, the
growth rate during the super
normal growth period, the
length of the supernormal
period, the long run growth
rate, and the rate of return
required by investors.
2. Use the constant growth model
to determine the stock price
after the firm reaches a stable
growth situation.
3. Set out on a time line the cash
flows dividends during the
supernormal growth period and
the stock price once the
constant growth state is
reached; then find the present
value of these cash flows. The
present value represents the
value of the stock today.