Business, Legal & Accounting Glossary
A way of valuing a share based on the net present value of the dividends that you expect to receive in the future.
The simplest version of the model assumes that the company’s dividend rate remains constant. The ‘fair’ price of the share is the dividend (in pennies per share) divided by the required rate of return. So if you want 10% a year from your shares, the value of a company paying a 7p dividend is 70p. If you think a return of 8% is satisfactory, the value of the same share is 87.5p.
A more complex model assumes that the dividends of the company grow at a consistent rate. The fair price to pay is the next dividend divided by the required rate of return minus the rate at which dividends are expected to grow. So if the 7p dividend is expected to grow at 5% per year, an investor requiring an 12% return would value the shares at
(7p x 1.05) divided by (0.12 – 0.05)
= (7.35p) divided by (0.07)
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This glossary post was last updated: 26th April, 2020 | 0 Views.