Value is what we perceive and price is what we pay. Valuation is the process to know the worth of the thing for which we pay a price. It a process through which we can refine our investment decision and it also serves a base to buy an asset.
- Valuation means present value of all the future benefits
- Financial theory says that the value of a stock is worth all of the future cash flows expected to be generated by the firm, discounted by an appropriate risk-adjusted rate
- According to the DDM, dividends are the cash flows that are returned to the shareholder
Zero Growth Model
This model assumes that there will be no growth in the dividend paid by the company and the company will pay the same dividend every year. This means that there is a 100% Dividend payout ratio and no retention of dividends.
Valuation:
Constant Growth Rate Model (Gordon Model)
A model for determining the intrinsic value of a stock, based on a future series of dividends that grow at a constant rate. This model assumes the constant growth rate over the long term.
Valuation:
Limitations:
- Applicable to those firms which pay dividend
- Applicable only to those firms that are growing at a steady growth rate
- If the growth rate is equal to the required rate of return the price of the stock approaches to infinity
PVS (Prashant V Shah) 