Dividend growth model
It can be described as a model which deals with the dividend and its growth constituting contemporary discount and it is called as an Stock Valuation Model in economics. Moreover, to understand this model in simple terms, assume that you are paid $X per year by the stock with the growth rate of Y% and you as an investor, need the rate of return which is called as the variable in this case, supposed to be Z% on your investment, then calculate your Dividend Growth Model with the help of following formula-
Value$ = (Present Dividend (1 + dividend Growth)) / (Return Needed dividend Growth).
I.e. Value$ = X$ (1 + Y)) / (Z Y)
Whatever value$ you get is your Y% average annual return that is yielded by stock at that value, based on the contemporary situation.
So in short, one can understand that the stock valuation calculation needs three basic things like 1) The Contemporary dividend, 2) Growth of that dividend and 3) Rate of Return you need.
Why a Stock Valuation Process is important in Dividend Growth Model:
You as an investor always need to plan your tax paying schedule which is very necessary for your contemporary off market business transactions and for that you should know about the contemporary stock value. Also this stock valuation process helps you to calculate the present stock value to resolve your stock valuation litigation. The ultimate purpose to know about the Potential Stock Market Value is served by this process, which is very useful to estimate a fair value of companies present in the stock market and their stocks. To know about accurate Potential Market Value, this theoretical calculation of the stock value with the use of basic economic criteria, should match perfectly with the stock market criteria.
Limitations of calculating stock value:
Many growth stocks constitute significantly varying present growth rate year by year
with the cost of capital. In such case it is not possible to calculate the exact stock value with the help of this process.
Types of Dividend Growth Model:
Mainly there are two types of dividend growth models that are used to calculate present stock values of stock market companies. They are as follows:
1) Constant dividend growth model and
2) A variable or two stage growth dividend models.
Use of Constant Dividend Growth Model:
For mature companies where the dividend growth remains steady, this constant dividend growth model is very useful to analyze their stock value. Most of the blue chip companies in the stock market have a constant dividend growth and you can analyze their present stock value within a very short period of time with the help of this dividend growth model.
Use of variable or two stage dividend growth model:
There are some companies in the stock market which are not yet matured owing to their constant growth phase. This two stage dividend growth model facilitates adjustment to estimate their present value by considering the time assumption and the magnitude of the present growth of these companies.
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