Just out of curiousity, if you have a stock that will have dividends growing at a G > R The value you of that stock is infinite, correct? I meen yeah this would not exist in reality, but mathmaticly the PV of each future cash flow would be bigger than the one before it…therefor infinite
you cant use DDM with that case as you know. r - g would be negative which makes no sense. its tough to make sense out of an undefined equation.
you meen you cant use gordon growth… gordon growth and DDM are two diff things… in theory you can use a DDM, but you should get a value of infinite
gordon growth is a variation of DDM. but yeah you are right it would be infinite
Think of it practically. If you require a rate of, say, 10% on a stock, but the stock is actually growing (or returning) a rate of 12%, would you complain? You won’t even have to value it because you know you are getting more than compensated for taking a long position in the stock. Does it make sense?
yeh it makes sense, i was just seeing if in theory its value would be infinite, or if there is some other way to quantify it… again all theory, if such an asset existed i guess we would all quit the CFA and invest in it
If you could find a company that would have the growth rate that exceeds the cost of capital, it would have an infinitely high price. The key issue is that such growth is not sustainable. In the long run ROE is close to cost of capital (normal return is zero). Since growth rate is smaller than ROE, it will be smaller than the cost of capital in the long run.
I believe the text actually states this, but growth CANNOT be sustained above r in the long run…the firm would eventually BE the economy. to say a firm will have “infinitely high price” is wrong. A company may a high growth stage, but eventually the growth will slow down to the long run rate of the economy. So by valuing a company with an assumption the growth is ‘forever above r’ is wrong; the model would be flawed, and ultimately the valuation being worth nothing more than garbage…
so the risk free rate in USA is pretty low 2-3%, If i am not wrong I am sure there would be companies which are going more than this. Are prices sky high? I dont think so
'so the risk free rate in USA is pretty low 2-3%, If i am not wrong I am sure there would be companies which are going more than this. Are prices sky high? I dont think so " do you usally discount stocks at the risk free rate… I dont think so…
i confused R with risk free rate, yeah i m stupid
nah, thats what R refers usually anyway so i should have said, Re>g , or Ke>g
I get the feeling - though I don’t want to work through it right now - that g can’t actually be bigger than r. There has to be something in the calculation of the required return that takes into account the kind of growth parameters that precludes g ultimately exceeding r.
The DDM model necessitates a “stable and sustainable growth rate”. This rate cannot exceed the stable growth of the economy. If g is > r, that probably means that you need to use a multi-stage model, since the g is not sustainable forever. The DDM model also works best for high dividend paying, stable firms. If you have a very high g, that would mean you are paying out low Dividends, Div = ROE*(1-b) and g = ROE*b – where b is plowback growth percentage. Dividends are also supposed to reflect FCFE, if g is a really high for a number of years (or forever, as assumed), that would mean most cash would be on hand instead of paid out. Assumptions must not violate the model, or it cannot be used.
gulfcfa Wrote: ------------------------------------------------------- > nah, thats what R refers usually anyway > > so i should have said, Re>g , or Ke>g Re is always greater than g because g is the portion of Re that gets reinvested. In the short run g > Ke is possible but in equilibrium (in the long run), g < Ke.
You should refer back to Level 1 readings: keyword - SUPERNORMAL GROWTH. GG is just one of many valuation methods. When a firm’s growth (rr*ROE) exceeds its required return (just think Google, Intel, any successful tech stocks), GG cannot be applied due to the structural set-up of the equation, and the text makes that clear. In this case, you would use valuation with temporary supernormal growth that basically states: V = [D*(1+g)]/(1+r) + [D*(1+g)^2]/(1+r)^2 + … [D*(1+g)^n]/(1+r)^n + [[D*(1+g)]^n/(r-g)]/(1+r)^n. Notice the last piece of the equation basically has the GG model embedded, except now the g rate used in it should be lower than r, since it’s a perpetual rate, i.e. a sustainable rate, assuming that we are in a competitive free enterprise economy. Relative valuation that uses multiples is another alternative - and it’s probably just one among many many more that I never even heard of.
most of you are trying to teach me level 1 stuff…your are missing the point HYPOTHETICAL< HYPOTHETICALr for ever, cause he was a huge ROE and he can keep it that way. What is the value of this firm !
gulfcfa Wrote: ------------------------------------------------------- > most of you are trying to teach me level 1 > stuff…your are missing the point > > HYPOTHETICAL< HYPOTHETICALr for ever, cause he was > a huge ROE and he can keep it that way. > > What is the value of this firm ! Value of firm = you’re going to fail level 2
Ok then what you are describing is a perpetuity. Estimate what kind of dividends you can expect to receive from your super a-rab money growth and divide by required return.
“Ok then what you are describing is a perpetuity. Estimate what kind of dividends you can expect to receive from your super a-rab money growth and divide by required return” It is not a perpetuity, it is growing…at a rate bigger than R If someone is not convinced its value would be infinite, open an excel sheet… in column 1 put years, 0, 1, 2 etc in column 2 start with div of 1, grow it by 10% as you go down the coloumn in column 3 discount the value in column two by (1.05)^(colomn 1) as you go on, the values in colomn 3 just keep getting bigger and bigger, so your stock has the value of infinite… anyway, i guess we can forget the topic, cause come to think about it even in my scnerio from hell where the company is owned by a dictator, that wont last for ever…