Dividend and Non Dividend
Stock Valuation
One primary reason individuals invest in stocks is to receive returns on their investment in the form of
dividends. Not all companies opt to offer dividends to their investors, however. In their article The Dividend
Discount Model in the Long Run:
A Clinical Study, the authors discuss the importance of three variables that
affect the valuation of a dividend and non dividend
paying stocks. They note how valuation is influenced by
the size, timing, and uncertainty of cash flows that the asset will generate for investors over its lifetime.
Use the Internet to access financial sites to find a company that does not pay dividends.
From a theoretical view, explain the merits and/or pitfalls of using the dividend growth model to estimate the
stock price of a non dividend
paying stock.
Then, compare and contrast how these variables affect the valuation of a dividend paying stock and a non dividend
paying stock.

Dividend and Non-Dividend Stock Valuation

1. Merits and Pitfalls of Using the Dividend Growth Model for Non-Dividend Paying Stocks

The Dividend Growth Model (DGM), also known as the Gordon Growth Model, is a widely used method to value dividend-paying stocks. It calculates the intrinsic value of a stock based on the present value of its future dividends, assuming a constant growth rate. The formula is:

P0=D1r−gP0​=r−gD1​​

Where:

• P0P0​ = Current stock price

• D1D1​ = Expected dividend in the next period

• $r$ = Required rate of return

• $g$ = Constant growth rate of dividends

Merits of Using DGM for Non-Dividend Paying Stocks:

• Theoretical Framework: The DGM provides a structured approach to valuing stocks based on cash flows. Even for non-dividend paying stocks, the model can be adapted by assuming future dividends (e.g., when the company starts paying dividends).

• Focus on Cash Flows: The model emphasizes the importance of cash flows, which are critical for stock valuation regardless of whether the company pays dividends.

Pitfalls of Using DGM for Non-Dividend Paying Stocks:

• No Dividends: The DGM relies on dividends as the primary cash flow. For non-dividend paying stocks, this makes the model inapplicable unless speculative assumptions are made about future dividends.

• Growth Rate Assumptions: Estimating the growth rate ($g$) for non-dividend paying stocks is challenging, as these companies often reinvest earnings into growth rather than distributing them as dividends.

• Uncertainty: Non-dividend paying stocks are often growth-oriented companies with uncertain future cash flows, making the DGM less reliable.

2. Comparison of Variables Affecting Dividend and Non-Dividend Paying Stocks

The valuation of both dividend and non-dividend paying stocks is influenced by three key variables: size, timing, and uncertainty of cash flows. However, the impact of these variables differs between the two types of stocks.

Variable	Dividend Paying Stocks	Non-Dividend Paying Stocks
Size of Cash Flows	Dividends provide a measurable and predictable cash flow to investors.	Cash flows are reinvested into the business, making them less tangible for investors.
Timing of Cash Flows	Dividends are paid regularly (e.g., quarterly), providing immediate returns to investors.	Cash flows are realized in the future through capital appreciation or eventual dividends.
Uncertainty of Cash Flows	Dividends are relatively stable and predictable, reducing uncertainty.	Future cash flows are highly uncertain, as they depend on the company’s growth and profitability.

3. Example of a Non-Dividend Paying Stock

Company: Amazon (AMZN)
Amazon is a well-known example of a non-dividend paying stock. The company reinvests its earnings into growth initiatives, such as expanding its e-commerce platform, cloud computing services (AWS), and other ventures. Investors in Amazon primarily seek returns through capital appreciation rather than dividends.

Valuation of Amazon:

• Dividend Growth Model: Not applicable, as Amazon does not pay dividends.

• Alternative Models: Amazon’s valuation is typically based on discounted cash flow (DCF) or price-to-earnings (P/E) ratio, which focus on future earnings and growth potential rather than dividends.

4. Theoretical Comparison

• Dividend Paying Stocks:

  • Strengths: Provide regular income (dividends) and are often less volatile.

  • Valuation: Easier to value using models like DGM, as dividends provide a clear cash flow stream.

  • Example: Coca-Cola (KO), which has a long history of paying consistent dividends.

• Non-Dividend Paying Stocks:

  • Strengths: Offer higher growth potential, as earnings are reinvested into the business.

  • Valuation: Require alternative models like DCF or P/E, as there are no dividends to base valuation on.

  • Example: Tesla (TSLA), which reinvests profits into innovation and expansion.

5. Conclusion

The Dividend Growth Model is a useful tool for valuing dividend-paying stocks but is not suitable for non-dividend paying stocks due to the absence of dividends. Non-dividend paying stocks, often growth-oriented companies, require alternative valuation methods that focus on future earnings and growth potential. The key variables—size, timing, and uncertainty of cash flows—affect both types of stocks but manifest differently. Dividend-paying stocks offer predictable cash flows, while non-dividend paying stocks rely on future growth and capital appreciation.

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References

• Damodaran, A. (2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset. Wiley.

• Gordon, M. J. (1962). The Investment, Financing, and Valuation of the Corporation. Irwin.

• Financial websites such as Yahoo Finance, Bloomberg, and Investopedia for stock data and analysis.