One of your colleagues has recommended that you buy 10 shares in a certain company, say, ABC Ltd. He tells you that the company has a good track record of paying regular dividend every year and the dividends are likely to grow at a rate of 4% per year on an average for the foreseeable future. The next dividend is expected to be $1.50 per share and the shares are selling in the secondary market for $28.50 per share. As per your financial plans and life profile, you feel that any risky investment like in shares of a company, should earn at least 9% per annum. 1. Will you buy these shares? Why and support your reasoning with relevant computations.
Dividend Valuation
Dividend refers to a reward or cash that a company gives to its shareholders out of the profits. Dividends can be issued in various forms such as cash payment, stocks, or in any other form as per the company norms. It is usually a part of the profit that the company shares with its shareholders.
Dividend Discount Model
Dividend payments are generally paid to investors or shareholders of a company when the company earns profit for the year, thus representing growth. The dividend discount model is an important method used to forecast the price of a company’s stock. It is based on the computation methodology that the present value of all its future dividends is equivalent to the value of the company.
Capital Gains Yield
It may be referred to as the earnings generated on an investment over a particular period of time. It is generally expressed as a percentage and includes some dividends or interest earned by holding a particular security. Cases, where it is higher normally, indicate the higher income and lower risk. It is mostly computed on an annual basis and is different from the total return on investment. In case it becomes too high, indicates that either the stock prices are going down or the company is paying higher dividends.
Stock Valuation
In simple words, stock valuation is a tool to calculate the current price, or value, of a company. It is used to not only calculate the value of the company but help an investor decide if they want to buy, sell or hold a company's stocks.
Question 1
One of your colleagues has recommended that you buy 10 shares in a certain company, say, ABC Ltd. He tells you that the company has a good track record of paying regular dividend every year and the dividends are likely to grow at a rate of 4% per year on an average for the foreseeable future. The next dividend is expected to be $1.50 per share and the shares are selling in the secondary market for $28.50 per share.
As per your financial plans and life profile, you feel that any risky investment like in shares of a company, should earn at least 9% per annum.
1. Will you buy these shares? Why and support your reasoning with relevant computations.
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