Take it easy guys, it’s all good. No one lost and no one won, it’s a forum to share and debate ideas–constructive ideas. Getting back to the question, i think it’s fairly simple. Let’s take a look at it again: Holding all other factors constant, which of the following is expected to grow at the same rate as dividends in the infinite period DDM? A. Sales B. ROE C. Stock price D. All of the above The first part of the question is very important " Holding all other factors constant"… which means, we are only concerned with the strict relationship between dividend growth rate and stock price. From the equation P=D/k-g, it is simple to conclude that D and P are directly proportional, so an increase in D will mean an equal increase in P (again, holding all others factors constant). Now, if you are my type and like to exercise your brain proving this relationship (dividend growth and stock price), then read Sean’s post above (12:58 AM) he does a good job explaining it… Also, if you wanna get that answer right using the process of elimination, then do your reading and u will realize that they mention a million times that ROE is constant (in such examples, since we are “holding all other factors constant”) and sales are not necessarily increasing at the same rate --which in turn means choice D (all of the above) cannot be true, so we are left with one option: choice C=stock price.
Sean, we’re having two different discussions here. The mathematics of the model speaks for itself. Yes, if you measure the infinite-period DDM at sequential time periods, you get a P0 that’s changes by g precisely. What I’m saying is that this model is static and not intended for time-series analysis. If everyone in the market could predict how a stock price would change from period to period then this would be exploited by arbitrage and prevented from actually taking place. The stock price contains all the market’s expectations at any given single point in time (Strong-Form EMH). The LI exam simply will not use the infinite-period DDM in the same manner that this sample question. The candidate will simply be asked to calculate a stock’s intrinsic value at a single point in time using the model, and possibly use that answer to determine whether a stock should be purchased. Furthermore, there’s no need to offuscate matters by discussing the residual income model (which BTW is LII material and more closely related to Justified P/B than to DDM, which is related more to Justified P/E). And finally, the difference between you and I is that I’ve stuck to the debate at hand since the beginning, even if passionately, whereas you just seek out personal attacks. I don’t think I’d be going out on a limb here to claim that I’m largely a welcomed presence in the forums, not because I’m correct all the time (which I’ll be the first to concede is not the case), but because I’ve invested considerable time over many months assisting candidates, typically providing thorough explanations and facilitating discussion. You’re new here. If you want respect, it takes more than being right all the time (which no one is, not even JoeyD), you have to conduct yourself appropriately. You stifle debate by attacking people. Bottom line, tough guy, if you want to talk trash on a personal level, then come out West and handle it in-person. Otherwise, step off. Your pompous attitude isn’t welcome here.
You’re the one with the pompous attitude here hiredguns, you started swearing at me thereby taking that passion of yours a little too far. You started attacking me and taking it to a personal level and I have responded in kind. If you can’t take the heat then don’t start a fight. I provide respect whenever it is due, but your explitive ridden tirade did not gain my respect nor anyone else’s no matter how much help you’ve provided to others here. Anyway, you’re still wrong. You CAN use the model to determine the theoretical fair value of the stock at any point in time. If you had ever examined the derivation of the DDM model you would have realised that the stock can be modelled as a number of dividends in the future plus a terminal value. That terminal value is the value of all dividends after that point in time and is also the expected value of the stock at that time in the future. Yes, it does predict what the value of the stock will be at any time in the future, but that prediction is based on the current assumptions holding. In reality there are economic shocks and expectations of company performance may not be met, which would mean that the prediction is probably not going to be correct and that there will be a DISTRIBUTION of future possible stock prices, but the values I have shown above are the EXPECTED values of that distribution. So whenever you use the DDM in any question, you are assuming what I have just said. The mathematics of the model says so. Yes, the model is often used at time zero, but it can also be used at any other point in time.
Sean, I see your point about the distribution. Moreover, I apologize if my loss of temper offended you personally. That wasn’t my intention and I recognize that I sometimes take profanity and sarcasm a bit far. Here’s my proposal: let’s just drop this please and move on to other discussions, letting this thread finally die. In the meantime, I’ll do my part and revisit all the literature I can find on the DDM. Afterall, I’m in these forums (and this program) to learn. I hope you’ll accept my apology and proposal. Cheers.
The arbitrage situation you’re talking about is if the stock prices at different points in time are CERTAIN and do not have a probability distribution as I have said. If the prices were certain then the stock should provide a return equal to the risk free rate and you would short the risk free security and buy the stock. But, as the stock is risky and has a distribution of future stock prices at each point in time then it is not riskless arbitrage, it is taking a levered position in the stock, which has a positive EXPECTED payoff which is NOT certain.
Sure no problem guns, I accept your apology and apologise myself for any personal attacks that were made.