regulatorycapitalratiosarecomputedonthebasisofbook
value of equity.
Insummary,then,thedividenddiscountmodelhasfarmore
applicabilitythanitscriticsconcede.Eventheconventional
wisdomthatthedividenddiscountmodelcannotbeusedto
valueastockthatpayslowornodividendsiswrong.Ifthe
dividend payoutratio is adjusted to reflectchanges in the
expectedgrowthrate,areasonablevaluecanbeobtainedeven
for non-dividend-paying firms. Thus, a high-growth firm
payingnodividendscurrently canstillbe valuedbased on
dividendsthatitisexpectedtopayoutwhenthegrowthrate
declines.
Extensions of the Dividend Discount Model
Onereasonforthefallofthedividenddiscountmodelfrom
favorhasbeentheincreasedusedofstockbuybacksasaway
ofreturningcashtostockholders.Asimpleresponsetothis
trendistoexpandthedefinitionofdividendstoincludestock
buy-backs and to value stocks based on this composite
number. In this section, we consider the possibilities and
limitationsofthisexpandeddividenddiscountmodelandalso
examinewhetherthedividenddiscountmodelcanbeusedto
value entire markets or sectors.
Expanded Dividend Discount Model
Inrecentyears,firmsintheUnitedStateshaveincreasingly
turned to stock buybacks as a way of returning cash to
stockholders. Figure 5.4 presents the cumulative amounts
paidoutbyfirmsintheformofdividendsandstockbuybacks
from 1988 to 2002. The trendtoward stock buybacks has