CHAPTER 5
Equity Discounted Cash Flow Models
In the three preceding chapters, we considered the basic
principlesgoverningtheestimationofdiscountratesandcash
flows.Intheprocess,wedrewadistinctionbetweenvaluing
theequityinabusinessandvaluingtheentirebusiness.Inthis
chapter,weturnourattentiontodiscountedcashflow(DCF)
models that value equity directly.
Thefirstmodelsexaminedtakeastrictviewofequitycash
flowsandconsideronlydividendstobecashflowstoequity.
Thesedividenddiscountmodels(DDMs)representtheoldest
variantofdiscountedcashflowmodels.Whileabandonedby
manyanalystsasold-fashioned,theyarestillusefulinawide
rangeofcircumstances.Wethenconsiderbroaderdefinitions
ofcashflowstoequity,byfirstincludingstockbuybacksin
cashflowstoequityandbythenexpandingouranalysisto
coverpotentialdividends orfreecash flowstoequity. We
closethechapterbyexaminingwhythedifferentapproaches
may yield different values for equity per share.
DIVIDEND DISCOUNT MODELS
The oldest discounted cash flow models in practice are
dividenddiscountmodels.Whilemanyanalystshaveturned
awayfromdividenddiscountmodelsonthepremisethatthey
yieldestimatesofvaluethatarefartooconservative,several
of the fundamental principles that come through with
dividend discount models apply when we look at other
discounted cash flow models.