Help with DDM vs FCF (Minority Shareholder vs Controlling holder)

CFA Level II Equities
#1

I have read some posts on this topics but still havent figured out. Hope someone can help me with this! Thank you!

In the Kaplan notes Page 90 of the Euqity Book, it says

DDM (dividend discount model):

  1. appropriate measures as the perspective is that of MINORITY SHAREHOLDER

  2. However, it also states on the top of that page that" if the dividend policy dictated by the CONTROLLING INTERESTS bears a meaningful relationship to the firm’s underlying profitability, then dividends are appropriate.

FCF (free cash flow):

  1. more pertinent to a firm’s CONTROLLING SHARESHOLDERS

  2. However, in the sentence after that, it states that " FCF is also useful to MINORITY SHAREHOLDER because the firm may be acquired for a market price equal to the value to the controlling party.

In a word, both DDM and FCF can be used with MINORITY SHAREHOLDER and CONTROLLING SHARESHOLDERs, is that right? If that is the case, I dont even know what to select for this type of quetions now.

#2

Anyone? please help

#3

dududu100,

You will want to use a DDM if you are a minority shareholder in a firm (assuming they pay dividends). You will want to use a FCFF or FCFE model if you are a majority shareholder because you (as a controlling owner in the firm) have the ability to alter the dividend policy of the firm, thus making the DDM not very useful for analysis.

1 Like
#4

cpolesiak is right… As a minority shareholder, you cannot influence the dividend payment, and thus you should use DDM, and for shareholders with controlling interest, they have the power to influence the dividend that will be paid out, so use FCF for such analysis.

#5

Thanks for the reponse! Thank you!