Obviously theres a mix of art and science involved here.
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The other cells show other combinations in between those two extremes.
Enter the, dividend, discount, model, you can take that same approach, and tailor it specifically for analyzing a stock that pays good dividends, and this is the.This is why you should always have a margin of safety in your estimates.(Your discount rate should be your target rate of return.) But if those inputs are off even slightly, the whole valuation method will be off.This also means that the DDM tends to be better for high yielding dividend stocks with lower dividend growth, rather than lower yielding stocks with higher dividend growth rates.Model the, gordon growth model solves for the present value of an infinite series of future dividends.Given a dividend per share that is payable in one year and the assumption the dividend grows at a constant rate in perpetuity, the model solves for the present value of the infinite series of future dividends. .Growth, model, and the most straightforward form is called the Gordon Growth, model.To value a business, you would take the discounted values of all future annual expected cash flows, sum them together, and thats the fair value of the business.In this example, because I chose 5 for my estimated dividend growth, the output chart automatically adjusts to show the calculated fair values for 4, 5, and 6 growth.In this example, in addition to calculating the results for 5 dividend growth and a 12 discount rate, it will automatically show what the fair value is if it turns out that the stock only grows its dividend by 4, or if you use.This is logical: the purpose of a business is to produce cash flows, so the value of the business is equal to the sum value of all future discounted cash flows.
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Suppose you want to calculate the fair value of a stock using the Dividend Discount Model (which is explained in significantly more detail in the book and you estimate that the dividend will grow by 5 per year, and youre using 12 as your discount.