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(3 of 14) Ch.8 - "Zero growth dividend" stocks explained & example - YouTube
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Constant dividend, or zero growth dividend.
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Zero growth dividend implies that the dividend
is not growing, 0% growth rate.
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So if you're buying a share of stock today,
which is year zero on this timeline, then
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a constant dividend model says that every
year, or maybe it's not every year but every
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quarter right, whatever the time segments
are.
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But let's say it's every year.
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Then every year you will be receiving back
the same dividend amount, let's say $2 on
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your share.
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After one year another $2, after two years
another $2, after three years and so on forever,
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right.
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The same dividend every year forever.
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If we use notation D to, you know, to indicate
the dividend amount.
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So to find the stock price today, right, like
how much would you pay for such stock?
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What's the maximum you would be willing to
spend, right?
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You would need to apply, you know, the concept
from the earlier slides where it said that
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stock price today is the present value of
all future dividends.
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When dividends look like a perpetuity we need
to apply the present value of a perpetuity
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formula.
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We have it in Chapter Six.
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The formula says, take the cash flow amount,
and divide by the rate of return.
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So in the context of stocks, the present value
for perpetuity is nothing but the price that
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you would be willing to pay, to buy one share.
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And the repeated cash flow amount is our dividend
amount, right.
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OK.
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Let's do this example.
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Let's say stock of ABC Company sells for $18
per share.
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This company is expected to pay a $0.50 dividend
every quarter, and the required return is
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10%.
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Are shares of stock priced correctly?
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To answer this question, let's calculate how
much these shares should cost.
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What would be the correct pricing for these
shares.
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So every quarter it's $0.50 right.
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It doesn't say where the limit is, so it keeps
going like that forever, so it's a perpetuity
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with a $0.50 cash flow, recurring over and
over and over again, right.
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Then so to find the stock price today, or
price of year zero, capital P, subzero.
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We need to discount, you know, this perpetuity.
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So the dividend amount divide by the discount
rate.
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One little trick here, because we are working
with quarterly dividends, we also must use
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the quarterly interest rate in the denominator
of the formula.
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If the required return is 10% for here, then
we need to divide it by four to get the quarterly
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discount rate.
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So 10% for here, divided by four quarters
gives 2.5% quarterly rate of return.
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So we get $0.50 divided by 0.025 and that
gives $20.
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So are shares of stock priced correctly?
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No.
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We know that they sell for $18, but they should
cost $20.
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So would you buy such shares or would you
run away from the?
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Of course, you're going to want to buy them,
because they're underpriced by $2.
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They're cheaper than they should be $2.
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It's a great deal.
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