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Sir Good Afternoon,
In a particular question it is asked to discuss market capitalization of companies with the market capitalization calculated via dividend valuation ,methodParticulars ( As given in question)
A B C
Cost of Equity 11% 14% 12%
Market Capitalization 608 1042 1164
Increase in share price in last 12 m 1% 5% 10%Dividend policy followed by A is Constant dividend policy
Calculations on basis of above:
Particulars A B C
Market Capitalization
– One year growth rate 300 1068.75 779
– Three year growth rate 300 879.45 1052So i m not able to interpret what this difference in Valuation means . What is the expectations of the shareholders on the basis of valuation on basis of one year and valuation on basis of 3 years.Moreover how to link this with market valuations given in question.
In theory, the market value is the PV of the expected future dividends discounted at the shareholders required rate of return (which his dependent on the level of risk that they perceive in the company).
The problems are firstly that just because we know what the past dividend growth was, it does not mean that shareholders are necessarily expecting the same rate of growth in the future – they may be expecting it to be higher or they may be expecting it to be lower.
Secondly, we do not know how risky shareholders expect each of the companies will be in the future – the more riskiness they expect then the higher the return they will be requiring and therefore the lower the MV (and vice versa).Thankyou for your reply sir .
I have done an analysis of the above situation . Kindly tell me whether i am right or not .
In case of A Co that follows a constant dividend policy of $ 33 / year , shareholders know that they wont get anything extra unless their is a change in company policy so dividend paid may not be the driving force behind shareholders expectation and thats why there is a huge difference in market valuation given in question and market valuation as per dividend model.
May be in this case it expectation depends on the Earnings of the company .
Earnings were increasing at a higher rate in 2013 & 2014 but there is gradual increase in 2015 earnings , however still shareholders believe that there will be gradual growth in earnings next year too so 1 % increase is the result of the same.Expectation also depends on the nature of the shareholder ,type shareholders that would prefer A type of company would be people who want constant fixed earning(dividend) + slight capital appreciation via rise in price
In case of B that follows a constant dividend payout of 40 % , shareholders know that the more the profit the more the dividend ( or more the dividend more the profit earned by company ) , so dividend paid is the driving force behind shareholders expectation and thats why market valuation given in question and market valuation as per dividend model is almost same . .
Earnings in 2013 went negative that why there is a difference in valuation on basis of 3 years growth however there is good increase in 2015 earnings as a result of which dividend paid was good , and shareholders believe that there will be good growth in earnings next year too so 5 % increase is the result of the same.
B type of company would be people who want believe balance between both dividend and capital appreciation .In case of C that follows dividend payout from residual funds , shareholders know that the dividend paid is linked to the investment made . The driving force behind shareholders expectation should not be dividend paid but still market valuation given in question and market valuation as per dividend model is almost same, may be shareholders are also interested in dividend payments.
Valuation on basis of 3 years growth shows difference in value given in question and value calculated as dividend payout was less in 2013, however there is good increase in 2015 earnings and dividend , and shareholders believe that there will be good growth in earnings as well as dividend too so 10 % increase in share price is the result of the same.
C type of company would be people who are interested in dividend payments but it is not there priority. Long term capital appreciationis there priority. .What you have written seems sensible (however we do not provide a marking service on this website 🙂 ) 🙂
Haha…..I didn’t want marking and all …I just wanted to know whether what I have analysed is correct or not . I mean my understanding of the situation is correct or not.
Thanks for your help .
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