Equity - DDM vs FCF valuation

Hello… for those of you expert of enterprise evaluation… I have I think a basic question but for which there is not treatment in the curriculum I think…

When I use DDM I consider only cash available to shareholder and distributed, when I use DCF using FCFF or FCFE I am considering all the free cash flow generated by the company regardless retention ratio, which eventually is considered only embedded in “g” (ROE * RR) when calculating perpetuity on terminal value…

So at the end of the day shouldn’t an evaluation based on FCFE always been higher than one using Dividends? The latter considered only cash flow distributed for one particular year, the first one considers all the cash flow generated by the company, so numerator is higher

Hi. I’m not an expert on enterprise evaluation. This is only my two cents.
Here we go!

Let’s assume a mature company has a per-share FCFE of $ 100. (FCFE is the cash available for distribution to the common shareholder after payment of all the operational and capital expenditure). Currently, the company has no profitable investment on hand and FCFE will grow at less than the GDP growth rate. So the company pays dividends equal to its FCFE amount. In this PV of all the future dividend will be the same as PV of all the future FCFE.

Hi, so you are doing my same conclusion, because you are in the particular case in which all FCFE is all distributed. So, when this is not the case, valuation based on DDM brings to a lower result?

Imagine a simple case, took FCFE x share and Div. x share of Norwegian Cruises pre Covid or another company that pays regular dividend but that has a retention rate. Took just the perpetuity of these measures without assumptions on growth… the two valuation will differ

, Yes, you are right :relaxed:. If the expected FCFE is greater than the dividend, then the PV of FCFE will be larger than the PV of the dividend.

But I think that in the long run, when the company will not have any profitable projects ( where the expected return from the project is lower than the cost of capital), FCFE will be equal to the dividend.

Well keep this in mind. Unlike Dividends, FCFE can be massive. I can distribute 80% or all of it to my shareholders. The potential of distribution is super high here. In dividends you get a fixed amount and potentially miss out on what could be distributed to you. So obv FCFE valuation will be higher. Best way to think about is dividend is the son of FCFE (buyback being the other). Hope this helps.

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Not 100% in line, I think valuation method should bring (almost) to same result, the fundamental value of the company is one, if a method brings elsewhere then there is a problem with that. Not saying that methods gives exactly the same result, but neither that there should be a big discrepancy as it appear in this case…? For this reason I am still a little bit confused