In practice, a common way to value a share of stock when a company pays dividend
ID: 2727672 • Letter: I
Question
In practice, a common way to value a share of stock when a company pays dividends is to value the dividends over the next five years or so, then find the “terminal” stock price using a benchmark PE ratio. Suppose a company just paid a dividend of $1.50. The dividends are expected to grow at 16 percent over the next five years. In five years, the estimated payout ratio is 48 percent and the benchmark PE ratio is 28.
What is the target stock price in five years? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
What is the stock price today assuming a required return of 13 percent on this stock? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
What is the target stock price in five years? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Explanation / Answer
1) Target stock price in five years = $183.68
Calculations:
Expected dividend for the fifth year = 1.5*1.16^5 = $3.15
EPS for the fifth year = 3.15/0.48 = $6.56
P/E = market price per share/earnings per share and market price per share = P/E*EPS = 6.56*28 = 183.68
2) Stock price today assuming a return of 13%, is $107.81
It is the PV of dividends for the five years + PV of the stock price at the end of the fifth year
= 1.5*1.16/1.13 + 1.5*1.16^2/1.13^2 + 1.5*1.16^3/1.13^3 + 1.5*1.16^4/1.13^4 + 1.5*1.16^5/1.13^5 + 183.68/1.13^5
1.54 + 1.58 + 1.62 + 1.67 + 1.71 + 99.69 = $107.81
.