Welcome to Finance and Excel video number 63.
Hey, if you want to download this Excel workbook for chapter
7 or the PDFs for chapter 7, click on the link directly
below the video, and then scroll all the way
down to the Finance Excel section.
All right.
Oh, this video-- last video, we did a constant dividend.
So preferred stocks, we knew what the dividend was to be
and dividend would be based on the contract.
And so we developed a model to price--
or figure out the value of the stock.
In this video here, we want to look at the dividend growth
model.
And here, we have the assumption that dividends
are expected to grow at a constant percent per period.
Now again, this model is not for all stocks, but it actually,
does give some good valuations for companies
that have predictable stocks.
And in our first video, and the next couple ones after that,
we talked about how the price right now is
the discounted future dividend.
So here's dividend one, dividend two discounted back
two periods, dividend three discounted back three periods,
on out into infinity.
Now, if you do a little algebra on this, you get this.
And actually, you can reduce it down to this.
So what this formula says-- and this will be our dividend
growth model to value stock at time zero--
it's the dividend just paid times 1
plus the assumed constant growth rate, divided by discount
rate minus the growth rate.
And guess what?
This top part right here, the dividend right now times 1
plus the growth rate, that gives us dividend
one period out from now.
So the model can be reduced down to this.
So if you have dividend time zero, then you do this one.
If you have dividend at time one, then you use this one.
We will also use this--
an extrapolation from this in a later video.
But let's see how this basic dividend growth model works.
Let's go over to Excel.
Our goal is at price time zero to calculate the price.
We know that the dividend just paid is 50 cents.
Well, we can easily calculate our next dividend.
If it's got a growth rate of 2%, I say, equals,
hey, that times 1 plus.
And remember, we've seen this so many times in this class.
When you see this 1 plus or even like in our last chapter,
we saw 1 minus, the 1 always represents the full amount--
that's the 50 cents--
and the plus or minus represents the proportional change.
All right.
There's our dividend one period out from now.
So to calculate the price now or estimate.
These are all models that are used to estimate.
We take that dividend divided by R--
big R minus little g.
And so, $3.92.
If we see the stock selling for less than this,
we're going to buy it.
If it's more than this, we're not going to buy it.
Now oftentimes, you don't want to waste real estate to do
this, so all on one formula.
You would say, dividend, current dividend
times 1 plus our growth rate.
That will be the denominator.
Sorry, that will be the numerator.
The top of the fraction divided by our,
in parentheses, big R, discount rate minus our constant growth.
And then we'll get the same thing.
All right.
Let's go look at another example here.
Now this example-- oh, look, we're
already given the dividend at time one.
We know what the next dividend is going to be,
so it's basically done for us.
We take that-- the hard part's done-- we take
that, divide it by R minus g.
Now, what happens if R was bigger?
There's a few assumptions here for this model to work.
You actually have to have a reliable growth rate, right?
Constant pattern of dividends being paid,
and R can't be bigger than your growth rate.
And we'll see later how to deal with that in some situations.
But for this model here, R has to be greater than this.
If it wasn't, then this goes to infinity.
So there it is.
The stock should be $13.33.
All right.
And next video, we'll actually see what happens.
We'll graph what happens to this model as R changes
and as g changes and then see what happens to the price.
All right.
See you next video.