5: Valuing Sharesseen considerable growth in the number of young, high-growth companies in Australia. Companies that
are in their early stage of growth, or their life cycle, usually have an acute shortage of cash for operations.
This means there is no further cash available to pay dividends. Indeed, most advisers to start-up and high-
growth companies, such as angel investors or venture capital investors, will require the owners of these
new companies to plough back any cash flows into the businesses, so that they can sustain the growth.
The payment of dividends, which diverts cash out of the company, is not a good idea at this time. So new
companies may not have a dividend flow to provide a basis for valuation by the model outlined above.
Can we apply the share-valuation models covered thus far to companies that pay no dividends? Yes and
no. On the affirmative side, companies that do not currently pay dividends may begin paying them in the
future. In that case, we simply modify the equations presented earlier to reflect that the company pays its
first dividend not in one year, but several years in the future. However, predicting when companies will begin
paying dividends and what the dollar value of those far-off dividends will be is extremely difficult. Consider the
problem of forecasting dividends for a company such as Yahoo! Since its IPO in April 1996, Yahoo! has paid
no cash dividends even though its revenues have increased from about US$19 million to more than US$6.4
billion. Yahoo! has been profitable in recent years and had accumulated cash reserves close to US$3 billion
at the end of 2014.^8 Is Yahoo! ready to start paying dividends, will it continue to reinvest income to finance
growth, or will it be acquired by another company? In all likelihood, investors will have to wait several years
to receive Yahoo!’s first dividend, and there is no way to determine with any degree of precision when that will
happen. Consequently, analysts attempting to estimate the value of Yahoo! generally use other methods, such
as the free cash flow method or the ‘comparables’ approach described in the next sections.
What happens if a company never plans to pay a dividend or to otherwise distribute cash to investors?
Our answer to this question is that for a share to have value, there must be an expectation that the
company will distribute cash in some form to investors at some point in the future. That cash could come
in the form of dividends or share repurchases. If the company is acquired by another company for cash,
the cash payment comes when the acquiring company purchases the shares of the target. Investors must
believe that they will receive cash at some point in the future. If you have a hard time believing this, we
invite you to buy shares in Graham/Smart/Adam/Gunasingham Limited, a company expected to generate
an attractive revenue stream from selling its products and services. This company promises never to
distribute cash to shareholders in any form. If you buy shares, you will have to sell them to another
investor later to realise any return on your investment. How much are you willing to pay for these shares?
CONCEPT REVIEW QUESTIONS 5-2
2 Why is it appropriate to use the perpetuity formula from Chapter 3 to estimate the value of
preferred shares?3 When a shareholder sells ordinary shares, what is being sold? What gives ordinary shares their
value?4 Using a dividend forecast of $2.79, a required return of 10%, and a growth rate of 2.75%, we
obtained a price for Cochlear Limited of $38.48. What would happen to this price if the market’s
required return on Cochlear shares increased?8 Data from Google Finance and the Wall Street Journal. http://www.google.com/finance?q=NASDAQ:YHOO&fstype=ii and http://quotes.wsj.com/
YHOO/financials. Accessed 16 December 2015.