Dividend Discount Model Research Articles

Using Cash Flow Dynamics to Price Thinly Traded Assets: The Case of Commercial Real Estate

We propose a technique to infer cash flow yields for investment assets whose trades are infrequent, but for which cash flow data is available. We construct a Self-Propagating Rolling-Window Panel VAR framework, adapted from a Dynamic Gordon Growth Model setup. We use this framework to estimate yields and volatility in yields for untraded commercial properties as out-of-sample predictions from our VAR based on these properties’ cash flow data. We find that our predicted cash flow yields closely resemble ex-post realized transaction yields, and that these predicted yields even outperform appraisals in this respect. We find that this paradigm provides a good representation of commercial real estate yields, and propose that investors can readily apply this algorithm to infer values of untraded investment assets.

A Dynamic Approach to the Dividend Discount Model

We derive a dynamic model of the firm with endogenous investment and leverage ratio within the framework of the dividend discount model (DDM). Our valuation model incorporates two relevant components, namely, managerial flexibility and long-run growth. We dispense with any utility specification capturing the preferences of shareholders and obtain closed-form solutions for the firm problem. A standard parameterization suggests that the value of the real options and long-run growth opportunities can easily represent more than 8% and 10% of share price, respectively. We also find that these two components of the stock price are both complements and countercyclical. We finally identify industries where valuation models that do not incorporate these features can lead to considerable underpricing of securities.

Do House Price Levels Anticipate Subsequent Price Changes within Metropolitan Areas?

This research examines the relationship between hedonically controlled housing price levels and subsequent changes in those prices across locations within MSAs. Are areas with a high price relative to an “imputed rent” paying for higher appreciation? In an efficient market (e.g., Gordon Growth Model), as fundamentals (impute rent) differ across locations and change over time, anticipation of these should generate a positive correlation between (residual) price levels and subsequent price changes.We undertake these tests in four different MSAs using a panel of repeat‐sale house price indices that have been scaled to price levels with the hedonic attributes of the house and ZIP code. In three markets we find that identical houses in higher priced ZIP codes subsequently appreciate faster. In one market we find that there is little statistical difference.

Equity Valuation Meets the Sigmoid Growth Equation: The Gordon Growth Model Revisited

The valuation of equity is a central topic in finance and accounting from many fronts. However, equity valuation is still subjective as different analysts obtain target prices that are not similar despite using the same publicly available information. Growth has a substantial influence on the value of equities when using Gordon Growth Model. Nevertheless, initial high growth and a constant growth to perpetuity assumption whereby a company continues to grow indefinitely is considered to be naive and simplistic. Therefore, this study proposes the use of sigmoid growth curve equation that is expected to better capture practicalities of firm growth. The sigmoid curve consists of lag, exponential, stationary and decline phases. The aim of this study was to provide evidence of sigmoid growth patterns of Johannesburg Securities Exchange listed companies and to propose a model for valuing equities using principles behind the sigmoid growth curve. This has implications for improving accuracy when approximating the value of equities, detecting mispriced stocks and informing buy/ sell decisions. For this purpose, cumulative sustainable growth patterns of 64 JSE listed companies were examined using data from 1994 to 2014, followed by curve fitting to determine whether the profiles were sigmoid. Interestingly, 50% of the firms showed typical sigmoid growth patterns. Ultimately, a model was developed for valuing equities by replacing growth, g, in the Gordon Growth Model with equivalent parameters in the sigmoid equation. In conclusion, the findings of this study accentuate that the Gordon Growth Model for equity valuation must factor in the complex growth parameters of firms in order to circumvent mispricing shares.

The Use of Technical and Fundamental Tools By Indian Stock Brokers

This paper presents findings of an online questionnaire survey on the perceived importance of chartist/technical and fundamental analysis and the usage of Chartist Methods and Services and Valuation Techniques among stock brokers of Bombay Stock Exchange, India. Stock brokers rely more on fundamental analysis vis-à-vis technical analysis at longer forecasting horizons and rely more on technical analysis at shorter forecasting horizons. Among Chartist Methods and Services, Sentiment Indicators were most used and Chart Company or Analyst was least used by brokers. Among Valuation Techniques, Earnings Multiple Methods were most used and Dividend Discount Models were least used by brokers. Stock brokers' age correlates with usage of sentiment indicators and their gender correlates with the usage of computer graphics and services. Regarding the use of chartist / technical and fundamental analysis on seven forecasting horizons, four distinct forecasting styles among stock brokers could be identified through cluster analysis.

Fundamental Analysis Models in Financial Markets – Review Study

Abstract The purpose of this paper is an attempt to reach a better stock valuation model of the Fundamental Analysis Approach, by reviewing the theoretical foundations and literature reviews. By reviewing the theoretical foundations for each model of the fundamental analysis models, and sequentially beginning of the Discounted Dividend Model (DDM), through a Multiplier Models, and finally the Discounted Cash Flow Model (DCFM), we find that all these models have strengths, despite the lack of accuracy, because it is required financial efficiency market. Recently Ohlson (1995) stated the simulated benefit in the formulation of the Residual Income Model (RIM). The Ohlson Model identifies the relationship between stock values and accounting variables. By reviewing the literature reviews, in financial markets, we conclude that the best model that can be relied upon to predict stock value, that proved credibility in both emerging and developed markets, is Residual Income Model (RIM), which doesn’t require financial efficiency for its application.

Capital Expenditures, Depreciation, and Amortization in the Gordon Growth Model

This article discusses two common errors when calculating terminal value using the Gordon growth model—overstating depreciation in relation to capital expenditures and overlooking amortization's time limits. For a growing company, normalized capital expenditures must be materially higher than depreciation. Amortization of intangible assets is worth the present value of the future tax benefits and should be excluded from the base on which terminal value is calculated. Instead, the present value of the benefits should be added to enterprise value. Similar adjustments should be made for tax-loss carryforwards, limited-life royalties, and other limited-life income and expenses.

Editor's Column

Hello Everyone,Happy New Year!This Winter Issue has an interesting group of articles: Andre Loeffler's article, “Why Total Beta Produces Arbitrary Valuations: A Violation of the ‘No Arbitrage’ Principle,” should stir some in our community. Michael Emaleh's article, “A Compensation-Based Method of Valuing Small, Closely Held Businesses” should be of interest to those valuing small businesses. Gil Matthews' article, “Capital Expenditures, Depreciation and Amortization in the Gordon Growth Model,” is near and dear to my heart, having written a couple articles published in the Business Valuation Review over the years. Dwight Grant's article, “Thoughts on Calculating DLOMs,” presents additional perspectives regarding a topic that has real dollar impacts to taxpayers and others. Mike Vitti provides an epilogue to his massive work on valuation in the insolvency context that we have had the privilege to publish over the last three issues.Next issue, volume 34.1, Spring 2015, will contain, among other articles, Eric Sondheim's “Implied Volatility and Volatility Smiles in Option-Pricing-Based Security and Business Valuations” and Joseph Thompson's “Expanding an Appraiser's Toolbox with Credit Default Swaps.” These will offer concepts and information that we have not seen a lot of.Sincerely,Daniel L. McConaughy, PhD, ASA

Growth Expectations, Dividend Yields, and Future Stock Returns

According to the dynamic version of the Gordon growth model, the long-run expected return on stocks, stock yield, is the sum of the dividend yield on stocks plus some weighted average of expected future growth rates in dividends. We construct a measure of stock yield based on sell-side analysts' near-term earnings forecasts that predicts US stock index returns well, with an out-of-sample R-squared that is consistently above 2% at monthly frequency over our sample period. Stock yield also predicts future stock index returns in the US and other G7 countries and returns of US stock portfolios formed by sorting stocks based on firm characteristics, at various horizons. The findings are consistent with a single dominant factor driving expected returns on stocks over different holding periods. That single factor extracted from the cross section of stock yields using the Kelly and Pruitt (2013) partial regressions method predicts stock index returns better. The performance of the Binsbergen and Koijen (2010) latent factor model for forecasting stock returns improves significantly when stock yield is included as an imperfect observation of expected return on stocks. Consistent with folk wisdom, stock returns are more predictable coming out of a recession. Our measure performs as well in predicting stock returns as the implied cost of capital, another common stock yield measure that uses additional information.

Determinants Of Firm Terminal Value: The Perspective Of North American And European Financial Analysts

Company valuation models attempt to estimate the value of a company in two stages: (1) comprising of a period of explicit analysis and (2) based on unlimited production period of cash flows obtained through a mathematical approach of perpetuity, which is the terminal value. In general, these models, whether they belong to the Dividend Discount Model (DDM), the Discount Cash Flow (DCF), or RIM (Residual Income Models) group, discount one attribute (dividends, free cash flow, or results) to a given discount rate. This discount rate, obtained in most cases by the CAPM (Capital asset pricing model) or APT (Arbitrage pricing theory) allows including in the analysis the cost of invested capital based on the risk taking of the attributes. However, one cannot ignore that the second stage of valuation that is usually 53-80% of the company value (Berkman et al., 1998) and is loaded with uncertainties. In this context, particular attention is needed to estimate the value of this portion of the company, under penalty of the assessment producing a high level of error. Mindful of this concern, this study sought to collect the perception of European and North American financial analysts on the key features of the company that they believe contribute most to its value. For this feat, we used a survey with closed answers. From the analysis of 123 valid responses using factor analysis, the authors conclude that there is great importance attached (1) to the life expectancy of the company, (2) to liquidity and operating performance, (3) to innovation and ability to allocate resources to R&D, and (4) to management capacity and capital structure, in determining the value of a company or business in long term. These results contribute to our belief that we can formulate a model for valuating companies and businesses where the results to be obtained in the evaluations are as close as possible to those found in the stock market.

An Investigation the Effect of Auditor Partner Rotation, Auditor Size and Tenure on Investors Expected Rate of Return in Listed Companies of Tehran Stock Exchange (TSE)

Aims: The purpose of this study is to determine the impact of Audit quality attributes such as audit partner rotation, auditor size and auditor tenure on Investors Expected Rate of Return in Listed Companies o f Tehran Stock Exchange (TSE). Study Design:This research in terms of purpose is of applied type and in terms of nature is semi-experimental.That its results can be useful for a wide range of corporate stakeholders. Place and Duration of Study:The used data have been extracted from the companies accepted in Tehran Stock Exchange (TSE) from 2005 to 2010 to determine the relationship between qualitative characteristics of audit and return rate expected by investors. Methodology: In this Study, cost of eq uity is the dependent variable and Auditor Partner Rotation, Auditor Size and Tenure as the audit quality characteristics are the independent variables. Also, three control variables of ratio of book to market value, financial leverage and firm size are in troduced to regression equations to control the impact of risk factors. In this regard, for measuring Cost of equity was used Gordon growth model. For data analysis and test of research hypothesis, multivariate regression equation has been used. To carry out the research, using Tadbir and Rahavard -e-Novin softwares, the required

Stock returns and the Miller Modigliani valuation formula: Revisiting the Fama French analysis

Fama and French (2006) use the dividend-discount model to develop the role of expected profitability, expected investment, and the book-to-market ratio as predictors of stock returns. One reported empirical result is anomalous. The valuation model establishes that the comparative static relation between expected returns and expected investment is negative, yet it appears to be positive and insignificant. We show that the posited valuation relations apply at the firm level, and not at the per share level at which they were tested. Once the variables are measured at the firm level, all the Fama French predictions are validated.

Dual-market Equilibrium of China’s Residential Housing Price

This paper constructs a structural dynamic equilibrium model based on a dual market system, which includes China’s residential housing market and the property rental market in China’s first-tier urban cities. The paper analyzes dual-market general equilibria under different scenarios as perceived since 2004. An open-economy Gordon growth model is also introduced to examine fair housing prices based on the assumption of no arbitrage. Empirical results indicate significant (but time-varying) price deviations from the equilibrium level since 2005 which are mostly driven by contingent demand and property investors. The paper concludes that the contingent purchasing demand supports China’s recent residential price hike and that speculation does not dominate the price boom. The recent quota policy has a theoretical downward pressure on the housing price in the short run but it also lifts property rents dramatically in the middle and long run.

A Dynamic Approach to the Dividend Discount Model

We derive a dynamic model of the firm with endogenous investment and leverage ratio within the framework of the dividend discount model. Our valuation model incorporates two relevant components, namely, managerial flexibility and long-run growth. We dispense with any utility specification capturing the preferences of shareholders and obtain closed-form solutions for the firm problem. A standard parameterization suggests that the value of the real options and long-run growth opportunities can easily represent more than 8% and 10% of share price, respectively. We also find that these two components of the stock price are both complements and countercyclical. We finally identify industries where valuation models that do not incorporate these features can lead to considerable underpricing of securities.

Deriving the Dividend Discount Model in the Intermediate Microeconomics Class

In this article, the authors show that the dividend discount model can be derived using the basic intertemporal consumption model that is introduced in a typical intermediate microeconomics course. This result will be of use to instructors who teach microeconomics to finance students in that it demonstrates the value of utility maximization in obtaining one of the first stock valuation models used in basic finance.

Calculating First Moments and Confidence Intervals for Generalized Stochastic Dividend Discount Models

This paper presents models of equity valuation where future dividends are assumed to follow a generalized Bernoulli process consistent with the actual dividend payout behavior of many firms. This uncertain dividend stream induces a probability distribution of present value. We show how to calculate the first moment of this distribution using functional equations. As well, we demonstrate how to calculate a confidence interval using Monte Carlosimulation. This first moment and interval allows an analyst to determine whether a stock is overor under-valued.

‘Is Residual Income Model (RIM) Really Superior to Dividend Discount Model (DDM)?’ – A Misconception

The development of the residual income model (RIM) has potential implications for the empirical researchers as the model specifies relationship between earnings and book values as proxies for equity values and accounting variables. Although researchers have supported RIM as an alternative to the dividend discount model (DDM), some empirical studies on RIM have triggered arguments on the superiority of the RIM over DDM. In theory, both models give the same value estimates; empirically, these value estimates changes with the changes in the assumption sets. In this paper, we show that both models provide the same values estimates when the terminal value can be forecasted. Although, under the perpetual growth rate model, the researchers have shown that empirically RIM outperforms DDM. We have shown that this superiority of RIM is misleading, as the transversality condition, a necessary assumption for deriving the RIM, is void under the perpetual growth rate scenario.

PRICING STOCKS BY USING FUZZY DIVIDEND DISCOUNT MODELS

Although the classical discount model (DDM) is a well- known and widely used model in evaluating the intrinsic price of common stock, the practical pattern of dividends, required rate of return or growth rate of do not generally coincide with any of the model's assumptions. It is just the opportunity to develop a fuzzy logic system that takes these vague parameters into account. This paper extends the classical DDMs to more realistic fuzzy pricing models in which the inherent imprecise information will be fuzzified as triangular fuzzy numbers, and introduces a novel -signed distance method to defuzzify these fuzzy parameters without considering the membership functions. Through the conscientious mathematical derivation, the fuzzy discount models (FDDMs) proposed in this paper can be regarded as one more explicit extension of the classical (crisp) DDMs, so that stockholders can use it to make a specific analysis and insight into the intrinsic value of stock. Stock represents an ownership interest in a corporation, but for the typical stock- holders, the purpose of holding the stock can be simply characterized by two fea- tures: one is to expect to receive the continuous payments by holding the stock; another is to earn a capital gain by selling the stock at a certain higher price. Generally speaking, common stocks are evaluated on the basis of either a corpora- tion's expected profitability or its expected distributions to stockholders. Since the analysis of common stocks can be based on the analysis of its payments, if stockholders can estimate the future cash-flow streams of payments by matching up an appropriate discount rate, then the theoretical value of the stock can be easily determined. The evaluating method is commonly known as the dividend discount models (DDMs) (1, 6, 15). However, such the classical DDMs do not take the imprecision into account that may be inherent in these parameters used in it. These parameters include future cash-flow streams of distributions, required rate of return, and growth rate of which are always subjectively quantified and determined by the listed companies. Thus, previous study has applied such a model to derive the upper and lower bounds of fluctuation of stock price, but the empirical result showed that the real stock price obviously went beyond the scope (16). In addition, most

The Terminal Value and Inflation Controversy

This journal recently published what was effectively a debate between Gunther Friedl and Bernhard Schwetzler (hereafter “F&S”), on the one hand, and Michael Bradley and Gregg Jarrell (“B&J”). B&J initiated the first round of the debate by criticizing the constant growth valuation model, commonly known as the “Constant Growth Model” or “Gordon Growth Model.” The Gordon Growth Model was introduced by Myron Gordon and Eli Shapiro (“G&S”) in a 1956 paper and has long been widely used by corporate and investment practitioners. F&S responded to B&J with a defense of the original G&S formulation.In revisiting this debate, the authors find that the models B&J and F&S advocate are at bottom two different versions of the same G&S constant growth model, but with quite different assumptions about the effect of inflation on the amount of capital reinvestment required to sustain businesses over time. The authors resolve the dispute by showing that both models, when using a consistent set of assumptions about inflation and capital reinvestment, produce identical growth rates and estimates of value. At the same time, however, the authors recognize that the two models (the G&S/F&S model, on the one hand, and the B&J model on the other) are likely to be appropriate for very different kinds of companies, and each for only small subsets of companies.

A semi-Markov approach to the stock valuation problem

In this paper, a general model is provided to evaluate a stock when the dividend growth rate is a discrete variable. This new dividend valuation model assumes that the dividend growth rate follows a finite state discrete time semi-Markov chain. An important consequence is that prices become duration dependent, i.e. they are influenced not only by the current state of the dividend growth process but also by the elapsed time in this state. This general valuation setting necessitates a more complex solution procedure with respect to the Markovian models. In fact, the valuation procedure of the semi-Markov model requires the solution of a system of first order linear difference equations with variable coefficients. The model is implemented by using experimental data freely available at http://www.econ.yale.edu/shiller/data.htm . The parameters of the model are estimated and the data strongly support the semi-Markov hypothesis of the dividend growth rate process. The paper generalizes previous contributions dealing with pricing firms on the basis of fundamentals.