Dividend and Non-Dividend Stock Valuation - Research Paper Example

Dividend and Non-dividend Stock Valuation Introduction According to Peris the discount growth model is a technique that is used to value dividend stocks and covers gains in both capital and dividends. A capital gain indicates the appreciation of price on stock price while dividends provide a regular investment on income. The stocks that do pay dividends are more attractive and profitable for conservative investors.Merits of using dividend growth modelFirst, the model is essential due to its simplicity in performing calculations.

Once the variables of the model are known, calculating the share of stock is forthright. Second, it is logical and sound given that it is built on the premise that investors purchase stock with a view of getting dividends in the future. Third, the model can be applied in the process of determining the predicted growth rate of a dividend. After calculating the price of a share of stock, it is easier for investors to determine the growth rate of dividends that is expected for the company (Pinto, 2010).

This is valuable if the estimated value of a share of stock is known so that it can be helpful in predicting the dividend price. Demerits of using the modelThe model reflects on rationality and not reality, and is established on the principle that investors invest in stocks that have got high returns. This is how investors are supposed to behave, despite the model not always reflecting how the investors should actually behave. Some investors purchase stocks of a company that happens to be more exciting and glamorous not considering its future financial position.

This shows why there is a discrepancy between the actual market value and stocks value (Groppelli & Nikbakht, 2006).Furthermore, it is difficult to determine the variables that are to be use in the model; while the model is simple and easy to use, it presents difficulty in the prediction of figures to be used in its analysis. Often companies’ dividends are not predictable hence, forecasting them is difficult. This explains why it is difficult to estimate the future company sales, which directly influences a company’s capability to grow and maintain dividends.

Comparison and contrasting Dividends are not the only source of income for investors. The model primarily deals with the money that is paid back to the investor and not the overall cash flow of the company. As such, the model aids in the development of investor biases. Therefore, investors do conform to their own expectations; hence, developing a tendency of coming up with their own values for stocks since most of the inputs are subjective. Those that are objective are likely to get accurate variables for the model (Lee, Lee & Lee, 2010).

The dividend growth model attraction is intuitive and simple hence, not useful in the valuation of most companies except for a limited number of high dividend paying and stable stocks. Subsequently, the model cannot be helpful in low dividend paying stocks and valuing of non-dividend paying stocks. As such, the model cannot be used to value a stock that pays no or low dividends. When the payout ratio is adjusted to reflect the changes in estimated growth rate, a reasonable value can be obtained for non-paying firms.

The model is also conservative in its estimation of value; in this, the estimation is based on the present value of the projected dividend (Besley & Brigham, 2008).Finally, the model helps in identifying the overvalued and undervalued stocks. The model has been tried, and the result shows that it does not provide for excess returns in the long run. It is unclear whether this model is useful at calculating the undervalued stocks or it substitute for irregularities in returns to the price earnings and dividend ratio (Pinto, 2010).

ReferencesBesley, S., & Brigham, E. F. (2008). Essentials of managerial finance. Mason, OH: Thomson/South-western.Groppelli, A. A., & Nikbakht, E. (2006). Finance. Hauppauge, N.Y: Barrons. Lee, C. F., Lee, A. C., & Lee, J. C. (2010). Handbook of quantitative finance and risk management. New York: Springer. Peris, D. (2011). The strategic dividend investor. New York, N.Y: McGraw-Hill. Pinto, J. E. (2010). Equity asset valuation. Hoboken, N.J: Wiley.