Dividend Discount Model
The value of a common stock is based on the present value of the future cash flows that will accrue to that stock. Of course, the present value calculation necessarily involves the use of a required rate of return (a discount rate) which reflects the risk. The textbook indicates that “To some extent, the two concepts of P/E ratios and dividend valuation models can be brought together. A stock that has a high required rate of return (Ke) because it’s risky will generally have a low P/E ratio. Similarly, a stock with a low required rate of return (Ke) because of the predictability of positive future performance will normally have a high P/E ratio”. In this discussion, you will examine the relationship between a stock’s required rate of return and its P/E ratio.
Watch the video, Dividend Discount Model (DDM)Links to an external site..
Select APPLE a publicly traded company that pays dividends.
Determine the most recent stock price and the total dividends paid over the past year.
Calculate the current dividend yield on the stock.
Calculate the required rate of return (Ke) for an investment in the common stock. You should use formula 10-9 in the textbook to do this calculation and use an assumed growth rate of 5%.
Prior to beginning work on this discussion forum, read Chapter 10 in the textbook. The value of a common stock is based on the present value of the future cash flows that will accrue to that stock. Of course, the present value calculation necessarily involves the use of a required rate of return (a discount rate) which reflects the risk. The textbook indicates that “To some extent, the two concepts of P/E ratios and dividend valuation models can be brought together. A stock that has a high required rate of return (Ke) because it’s risky will generally have a low P/E ratio. Similarly, a stock with a low required rate of return (Ke) because of the predictability of positive future performance will normally have a high P/E ratio” (Block et al, p. 322). In this discussion, you will examine the relationship between a stock’s required rate of return and its P/E ratio.
Watch the video, Dividend Discount Model (DDM)Links to an external site..
Select a publicly traded company that pays dividends. You may select any publicly traded company that pays dividends, or choose one of the companies discussed in 65 Best Dividend Stocks You Can Count On in 2021Links to an external site..
Determine the most recent stock price and the total dividends paid over the past year.
Calculate the current dividend yield on the stock.
Calculate the required rate of return (Ke) for an investment in the common stock. You should use formula 10-9 in the textbook from the attached photo to do this calculation and use an assumed growth rate of 5%.
Identify the current P/E ratio for the company from a source such as Yahoo! Finance or Barron’s.
In your post,
Show your calculations of the dividend yield and required rate of return (Ke), and present the P/E ratio.
Explain the relationship between your chosen company’s Ke and P/E ratio and what that relationship indicates about the risk of the company’s future cash flows.
Explain whether the general relationship between a high Ke and a low P/E ratio (or low Ke and high P/E ratio) is supported by the data for your chosen publicly traded company.
Predict the impact on the company’s stock price based on your forecast that the company will grow its dividends by a rate higher than 5%.
Sample Solution
Apple annual/quarterly common stock dividends paid history and growth rate from 2010 to 2022. Common stock dividends paid can be defined as the cash outflow for dividends paid on a company’s common stock. Apple common stock dividends paid for the quarter ending December 31, 2022 were $-3.768B, a 0.96% increase year-over-year. Apple common stock dividends paid for the twelve months ending December 31, 2022 were $-37.074B, a 2.74% increase year-over-year. Apple annual common stock dividends paid for 2022 were $-14.841B, a 2.59% increase from 2021. Tech stocks do not always pay a dividend but as Apple, Inc. has matured, it has become a reliable dividend stock. Dividend growth models can be used to help value stocks in the market. Apple’s dividend isn’t low when compared to dividends paid by other companies in the tech sector. What’s more, it’s common for growth companies, which Apple is still considered, to reinvest more cash back into the company instead of paying higher dividends.
