assumingthatfirmscancontinuetodrawonexternalfunding
to fund the dividend deficit in perpetuity.
Applicability
Notwithstandingitslimitations,thedividenddiscountmodel
can be useful in three scenarios.
1.Itestablishesabaselineorfloorvalueforfirmsthathave
cashflowstoequitythatexceeddividends.Forthesefirms,
the dividend discount model will yield a conservative
estimateofvalue,ontheassumptionthatthecashnotpaidout
by managers will be wasted on poor investments or
acquisitions.
2.Ityieldsrealisticestimatesofvaluepershareforfirmsthat
dopayouttheirfreecashflowtoequityasdividends,atleast
onaverageovertime.Therearefirmswithstableearnings,
especially in mature businesses, that try to calibrate their
dividendstoavailablecashflows.Atleastuntilveryrecently,
regulated utility companies in the United States, such as
phone and power, were good examples of such firms.
- In sectors where cash flow estimation is difficult or
impossible, dividends arethe only cash flows that canbe
estimatedwithanydegreeofprecision.Therearetworeasons
whyallofthecompaniesthatwehavevaluedinthischapter
using the dividend discount model are financial services
companies. Thefirst isthatestimating capitalexpenditures
and workingcapitalfora bank, aninvestmentbank, oran
insurance company is difficult to do.
6 Thesecondisthatretainedearningsandbookequityhave
realconsequencesforfinancialservicescompaniessincetheir