Calculating Intrinsic Value With the Dividend Growth Model
by Joe Lan, CFA
Valuing a stock or company is one of the most difficult tasks in investing.
Even the most seasoned investors may shy away from the challenge for a variety of reasons. However, determining whether a stock is trading at an attractive valuation is paramount to investment success. In this installment of the Financial Statement Analysis series, I continue to review valuation metrics, specifically the dividend discount model, which is one of the many methods used to determine fair value. I also delve into some of the challenges associated with calculating “intrinsic” value using this model.
The valuation (stock price) obtained using these formulas can vary substantially, so it is difficult to use the figures as exact buy or sell prices. However, there are several benefits that you can gain by valuing stocks yourself. It forces you, as an investor, to place a specific price on a stock that can be used as a gauge. Perhaps more importantly, valuing stocks enables you to take a deeper look at factors that drive stock price. Characteristics such as growth and fundamental elements such as income play a huge role in stock price value. You will be able to see how these metrics affect the share price determined through the dividend discount model.
...To continue reading this article you must be an AAII member.