Discounted Future Earnings

Finance allah shmoop what is the dividend discount model Well

it's a technique used to value companies or at least

it wass in the stone age And yet in the

nineteen fifties maybe which basically says that a company's value

is fully contained in the cash dividends it distributes back

to invest doors This model is only useful really for

its historical relevance We we just don't use that much

these days Yeah back in the old timey cave man

days when there was essentially no research of real merit

being done on the performance of investments of whatever flavor

the dividend discount model was the best thing investors had

to value an investment in a company And remember in

those days companies paid rial dividends that were a meaningful

percentage of the total value of the company Unless so

a company pays a dollar a share this year in

dividends Historically it's raised dividends at about three percent a

year like paid a dollar last you'd expect two dollars

three next year in dollars six and change the next

so well The dividend discount model discounts backto present value

And yes we have an opus on what president value

Means but here's the logline definition present value of all

future cash flows discounted for risk in time Back to

cars Yeah that thing well a few odd things are

worth noting in this horse and buggy era formula The

dividend discount model ignores the terminal or end value of

the company Like say twenty years from now the company

is sold for cash The dividends are all that are

really focused on though in our model that seem strange

to you Well maybe But let's say the discount rate

is ten percent in the risk free rate is four

percent for a total of fourteen percent a year discounted

back to the present So doing the math just looking

at the terminal value of say a hundred million bucks

in a sale to be made twenty years from now

Let's figure out what that's worth today Well you take

the one point one four Put it to the twentieth

power to reflect twenty years of discounted valuation compounding And

you say one point one four forty twenty powers about

thirteen point seven So to get the present value of

one hundred million bucks twenty years from now using this

discount rate Will you divide the hundred million by thirteen

point seven and that means that the one hundred million

dollars twenty years from now today is worth only seven

point three million bucks And yeah that's ah big haircut

kind of like this guy Well the formula focuses ah

lot on near term dividend distribution and it's Really more

interesting is a relic of original financial research in theory

than anything directly useful today And if you find this

interesting while then we may have a gig for you

here at shmoop finance central Yeah come on down We 00:02:39.715 --> [endTime] need writers good ones not like me