Eric H. Sorensen and David A.

Williamson

Some evidence on the value of dividend discount models

Financial Analysts Journal 1985
 FACTS – KOTAK & ING VYSYA
In theory one can apply the equation
to a stock estimate intrinsic value and
April Rather than use one analysts’ growth
compare intrinsic value and compare
2015 forecast as the necessary input for the last this value to current price.
two methods, we use a consensus forecast.Any deviation of the value from price
This procedure adjusts for security risk by
The
reflects a perception of relative
using a fundamental beta we generated for
Feb the study. attractiveness.
2015 Then we rank portfolios according to the A DEV exceeding one reflects
relative value to price ratings derived fromundervaluation.
each of these models and then subsequently
Nov evaluate ensuing performance over the
2014 following two years
HORIZONTAL MEREGER

• The dividend discount model (or variants of that model) has reached a new peak in popularity as a result of
investor demand for rational approaches to security selection.
• Preliminary tests of both simple and more complex valuation have concluded that disciplines ranking models
can add value.
• disciplines ranking models can add value.
Three Period models
Normalized earnings
Three Period Model
General Form of three period model
Performance Measures and Related Statistics
SPECIFIC INTENT OF M&A

• All current valuation models are variations of Williams’ basic proposition ,which may be expressed
mathematically as .
• In theory once can apply the above equation to a stock ,estimate intrinsic value , and compare this value to
current price.
• Any deviation of value from price reflects a perception of relative attractiveness.
• Out tests measure the deviation of value from price.
• A DEV exceeding one reflects undervaluation.
SPECIFIC INTENT OF M&A
• The calculation of DEV is highly subjective .
• It depends upon the particular form of the model from the
equation as well as the estimated inputs.
• Standard model forms,kindly note tend to make assumptions
about growth rate in annual dividends over time.
• Examining the constant growth rate framework, firm rate are such
that one growth rate is appropriate forever.
• It may sound a bit too simplistic brokerage firms use it to value
the firm as a whole.
 DEAL VALUE

• Multiperiod models

• These days it is a common practice that firms employ models that assume two or more growth rates being applicable to a firm’s
future.

• A two phase model has a one near term growth estimate(two-ten years in most models) followed by a steady state or logn term
growth model estimate.

• G,g2 – two distinct growth rates.

• A= number of years to steady state.

• A= number of years in period 1

• B= number of years to steady state.

• B-A= length of period 2

• G3= steady state growth rate.

Model application and choices
 DEAL STRUCTURE

• Intrinsic value definition was first presented by Irving Fisher and later applied to common stocks by John Burr Williams
in 1938.
• P=Intrinsic value
• Dt= estimated cash dividend in period t
• Kt= appropriate discount rate reflecting the time valus of money.
 WHAT WE WILL DO NEXT

• What is the appropriate number of periods or phase.

• This could be decided on the basis of earnings pattern or type of company(growth/cyclical/stable/energy),the more
phases ,the more complex .
• The researcher must also decide the length of each period.
• For example many firms allow each analyst to alter the length of period two.
 WHAT WE WILL DO NEXT

• What is the appropriate number of periods or phase.

• This could be decided on the basis of earnings pattern or type of company(growth/cyclical/stable/energy),the more
phases ,the more complex .
• The researcher must also decide the length of each period.
• For example many firms allow each analyst to alter the length of period two.
• An important decision for the researcher is whether to model dividend or earnings
growth.
• Using specific forecasts of dividends gives erroneous results especialy for non dividend
paying firms.
• The problem arises when an analyst is not consistent between estimating growth and
estimating payout policy,
• One may consider g to be the growth in either dividend or earnings per share associated
with future investment opportunities.
THANK YOU !!!