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The dividend valuation models, as discussed in the last two newsletters, must be used thoughtfully, making sure each input number can be defended. Today we’ll think about some of the key issues.
What is a normal growth rate?
Growth rates will be different for each company but for corporations taken as a whole dividend growth will not be significantly different from the growth in nominal gross national product (real GNP plus inflation) over the long run.
If dividends did grow in a long-term trend above this rate then they would take an increasing proportion of national income – ultimately squeezing out the consumption and government sectors. This is, of course, ridiculous.
Thus in an economy with inflation of 2 per cent per annum and growth of 2.5 per cent we might expect the long-term growth in dividends to be about 4.5 per cent.
Also, it is unreasonable to suppose that a firm can grow its earnings and dividends forever at a rate significantly greater than that for the economy as a whole. To do so is to assume that the firm eventually becomes larger than the economy.
There will be years, even decades, when average corporate dividends do grow faster than the economy as a whole and there will always be companies with much higher projected growth rates than the average for periods of time.
Nevertheless the real GNP + inflation growth relationship provides a useful benchmark.
Companies that do not pay dividends
Some companies, for example Alphabet (parent company of Google) and Warren Buffett’s Berkshire Hathaway, do not pay dividends. This is a deliberate policy as there is often a well-founded belief that the funds are better used within the firms than they would be if the money was given to shareholders.
Alphabet, for example, is investing in driverless cars, smart contact lenses, the android mobile operating system and a high-altitude balloon with Internet connectivity. It also needs cash for acquisitions; having purchased more than 150 companies, including Youtube.
The absence of a dividend presents an apparent problem for the DVM but the formulae can still be applied because it is reasonable to suppose that one day these companies will start to pay dividends.
Perhaps this will take the form of a final break-up payment, or perhaps when the founder is approaching retirement he/she will start to distribute the accumulated resources.
At some point dividends must be paid, otherwise there would be no attraction in holding the shares. Microsoft is an example of a company that did not pay a dividend for 28 years. However, in 2003 it decided it would start the process of paying out some of its enormous cash pile and paid a dividend.
Apple did not pay a dividend until 2012, but now pays the largest amount in the world, over $13bn a year.
Some companies do not pay dividends for many years due to regular losses. Often what gives value to this type of share is the optimism that the company will recover and that dividends will be paid in the distant future.
Problems with dividend valuation models
Dividend valuation models present the following problems.
- They are highly sensitive to the assu……………………To read the rest of this article, and more like it, subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
