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Finance allah shmoop what is the dividend discount model Well

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

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it wass in the stone age And yet in the

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

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is fully contained in the cash dividends it distributes back

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to invest doors This model is only useful really for

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

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these days Yeah back in the old timey cave man

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days when there was essentially no research of real merit

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being done on the performance of investments of whatever flavor

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the dividend discount model was the best thing investors had

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to value an investment in a company And remember in

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those days companies paid rial dividends that were a meaningful

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percentage of the total value of the company Unless so

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a company pays a dollar a share this year in

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

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

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three next year in dollars six and change the next

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so well The dividend discount model discounts backto present value

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And yes we have an opus on what president value

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

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future cash flows discounted for risk in time Back to

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cars Yeah that thing well a few odd things are

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worth noting in this horse and buggy era formula The

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dividend discount model ignores the terminal or end value of

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the company Like say twenty years from now the company

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is sold for cash The dividends are all that are

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really focused on though in our model that seem strange

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

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is ten percent in the risk free rate is four

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percent for a total of fourteen percent a year discounted

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back to the present So doing the math just looking

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at the terminal value of say a hundred million bucks

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in a sale to be made twenty years from now

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

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the one point one four Put it to the twentieth

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power to reflect twenty years of discounted valuation compounding And

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you say one point one four forty twenty powers about

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thirteen point seven So to get the present value of

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one hundred million bucks twenty years from now using this

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discount rate Will you divide the hundred million by thirteen

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point seven and that means that the one hundred million

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dollars twenty years from now today is worth only seven

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

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kind of like this guy Well the formula focuses ah

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

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interesting is a relic of original financial research in theory

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than anything directly useful today And if you find this

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interesting while then we may have a gig for you

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

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