Analysis of Financial Statements by Frank J. Fabozzi & Frank J. Fabozzi

Author:Frank J. Fabozzi & Frank J. Fabozzi
Language: eng
Format: epub
ISBN: 9781118331910
Publisher: Wiley
Published: 2012-09-28T00:00:00+00:00

Because common stock never matures, today's value is the present value of an infinite stream of cash flows. And also, common stock dividends are not fixed, as in the case of preferred stock. Not knowing the amount of the dividends—or even if there will be future dividends—makes it difficult to determine the value of common stock.

So what are we to do? Well, we can grapple with the valuation of common stock by looking at its current dividend and making assumptions about any future dividends it may pay.

The Dividend Valuation Model

If dividends are constant forever, the value of a share of stock is the present value of the dividends per share per period, in perpetuity. Let D represent the constant dividend per share of common stock expected next period and each period thereafter, forever, P0 represent the price of a share of stock today, and re the required rate of return on common stock. The required rate of return is the return shareholders demand to compensate them for the time value of money tied up in their investments and the uncertainty of the future cash flows from these investments.

The current price of a share of common stock, P0, is

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