Investors are known to invest their stocks in order that they receive their returns on what they have invested in terms of dividends. Nonetheless, not every company opts to offer dividends to investors. There are three main variables that affect dividend and non-dividend valuation and how each of the stock valuations is influenced. Some of the variable influences include uncertainty in terms of cash flows, timing and size of cash flows for the individual investors over time (Blume, 2010).
Companies that do not pay dividends
Any company that offers dividends can act as a potential symbol to investors as it would be viewed as one that settles down and that which had reached its prime time. Normally, dividends depend on earning size and are very fundamental in valuation of equity. Google Inc. is known to invest in future growth initiatives of companies. In view of this, Google Inc. does not offer dividends with the hope of continuing to expand to new business prospects. However, when viewed in terms of size, there are greater chances that Google will pay dividends in the coming years. Dividend growth models can be established since stock value can be equated to next year’s dividends divided by expected difference in rate of returns. This is also inclusive of the constant growth assumed in the dividends (Pastor & Veronesi, 2002).
Merits and/or pitfalls of using the dividend growth model
The good news is that this model is likely to benefit companies that look forward to paying dividends in the near future. The investors can also obtain returns on investments through purchasing stocks from those companies that do not offer dividends (Penman & Sougiannis, 2005).
The problem or pitfall for using this model is that a stock is only considered worth what another investor is able and willing to pay. The other worrying concern about this model is that it does not at any time include risks. It can be rounded up that the model only benefits those companies that pay dividends and whose dividends grow at a constant rate.
How variables affect the valuation of a dividend paying stock and a non-dividend paying stock
Dividend paying stocks perform better than their non-dividend counterparts given the consideration of immediate value. The non-dividend paying companies could make use of the model in a bid to predict its future growth if it were to resort to paying dividends.
Gordon Growth Model is effective in coming out with figures of stock valuation. It can however be used in companies paying dividends on a regular basis and at a constant rate. Additionally, the model can only work in case its assumptions are proven accurate. For the low or no-dividend paying companies, the model may prove inappropriate since the model bases its assumptions that the company growth will be constant (Black, 2009).
- Blume, M. E. (2010). Stock returns and dividend yields: Some more evidence. The Review of Economics and Statistics, 567-577.
- Black, F. (2009). The dividend puzzle. The Journal of Portfolio Management, 2(2), 5-8. (2016). Retrieved 21 January 2016, from http://elijahclark.com/dividend-and-non-dividend-stock-valuation/
- Pastor, L., & Veronesi, P. (2002). Stock valuation and learning about profitability (No. w8991). National Bureau of Economic Research.
- Penman, S. H., & Sougiannis, T. (2005). A comparison of dividend, cash flow, and earnings approaches to equity valuation. Cash Flow, and Earnings Approaches to Equity Valuation.