In practice, a common way to value a share of stock when a company pays dividend
ID: 2731064 • 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?
What is the stock price today assuming a required return of 13 percent on this stock?
Explanation / Answer
Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Dividend Growth rate 16.00% 16.00% 16.00% 16.00% 16.00% Expected Dividends 1.50 1.74 2.02 2.34 2.72 3.15 Dividend Payout Ratio Year 5=48% EPS year 5=3.15/48%=$6.56 Benchmark PE ratio Year 5=28 Price /EPS =28 Price =EPS*28=6.56*28=$183.68 So target stock price Year 5=$183.68 Terminal Stock Value 183.68 Total Expected future cash flows 1.74 2.02 2.34 2.72 186.83 PV factor @13% 0.885 0.783 0.693 0.613 0.543 PV of Future Cash flows 1.54 1.58 1.62 1.67 101.40 Sum of PV of Cash flows= $ 107.81 So Stock price today is $107.81