Dividend Discount Model (DDM)
In discounted cash flow (DCF) valuation techniques the value of the stock is estimated based upon present value of some measure of cash flow. Dividends are the cleanest and most straightforward measure of cash flow because these are clearly cash flows that go directly to the investor.
Intrinsic Stock Value (Valuation Summary)
Diageo PLC, dividends per share (DPS) forecast
US$
| Year | Value | DPSt or Terminal value (TVt) | Calculation | Present value at 11.71% |
|---|---|---|---|---|
| 0 | DPS01 | 3.09 | ||
| 1 | DPS1 | 3.65 | = 3.09 × (1 + 17.94%) | 3.26 |
| 2 | DPS2 | 4.22 | = 3.65 × (1 + 15.66%) | 3.38 |
| 3 | DPS3 | 4.78 | = 4.22 × (1 + 13.39%) | 3.43 |
| 4 | DPS4 | 5.31 | = 4.78 × (1 + 11.11%) | 3.41 |
| 5 | DPS5 | 5.78 | = 5.31 × (1 + 8.84%) | 3.32 |
| 5 | Terminal value (TV5) | 219.31 | = 5.78 × (1 + 8.84%) ÷ (11.71% – 8.84%) | 126.09 |
| Intrinsic value of Diageo PLC common stock (per share) | $142.90 | |||
| Current share price | $117.25 | |||
Based on: 20-F (reporting date: 2014-06-30).
1 DPS0 = Sum of the last year dividends per share of Diageo PLC common stock. See details »
Disclaimer!
Valuation is based on standard assumptions. There may exist specific factors relevant to stock value and omitted here. In such a case, the real stock value may differ significantly form the estimated. If you want to use the estimated intrinsic stock value in investment decision making process, do so at your own risk.
Required Rate of Return (r)
| Assumptions | ||
| Rate of return on LT Treasury Composite1 | RF | 4.79% |
| Expected rate of return on market portfolio2 | E(RM) | 13.48% |
| Systematic risk of Diageo PLC common stock | βDEO | 0.80 |
| Required rate of return on Diageo PLC common stock3 | rDEO | 11.71% |
1 Unweighted average of bid yields on all outstanding fixed-coupon U.S. Treasury bonds neither due or callable in less than 10 years (risk-free rate of return proxy).
3 rDEO = RF + βDEO [E(RM) – RF]
= 4.79% + 0.80 [13.48% – 4.79%]
= 11.71%
Dividend Growth Rate (g)
Dividend growth rate (g) implied by PRAT model
Diageo PLC, PRAT model
Based on: 20-F (reporting date: 2014-06-30), 20-F (reporting date: 2013-06-30), 20-F (reporting date: 2012-06-30), 20-F (reporting date: 2011-06-30), 20-F (reporting date: 2010-06-30), 20-F (reporting date: 2009-06-30).
2014 Calculations
1 Retention rate = (Profit for the year attributable to equity shareholders of the parent company – Dividends paid) ÷ Profit for the year attributable to equity shareholders of the parent company
= (3,797 – 2,074) ÷ 3,797
= 0.45
2 Profit margin = 100 × Profit for the year attributable to equity shareholders of the parent company ÷ Sales
= 100 × 3,797 ÷ 23,611
= 16.08%
3 Asset turnover = Sales ÷ Total assets
= 23,611 ÷ 38,784
= 0.61
4 Financial leverage = Total assets ÷ Equity attributable to equity shareholders of the parent company
= 38,784 ÷ 11,523
= 3.37
5 g = Retention rate × Profit margin × Asset turnover × Financial leverage
= 0.46 × 14.26% × 0.65 × 4.20
= 17.94%
Dividend growth rate (g) implied by Gordon growth model
g = 100 × (P0 × r – D0) ÷ (P0 + D0)
= 100 × ($117.25 × 11.71% – $3.09) ÷ ($117.25 + $3.09)
= 8.84%
where:
P0 = current price of share of Diageo PLC common stock
D0 = the last year dividends per share of Diageo PLC common stock
r = required rate of return on Diageo PLC common stock
Dividend growth rate (g) forecast
Diageo PLC, H-model
| Year | Value | gt |
|---|---|---|
| 1 | g1 | 17.94% |
| 2 | g2 | 15.66% |
| 3 | g3 | 13.39% |
| 4 | g4 | 11.11% |
| 5 and thereafter | g5 | 8.84% |
where:
g1 is implied by PRAT model
g5 is implied by Gordon growth model
g2, g3 and g4 are calculated using linear interpoltion between g1 and g5
Calculations
g2 = g1 + (g5 – g1) × (2 – 1) ÷ (5 – 1)
= 17.94% + (8.84% – 17.94%) × (2 – 1) ÷ (5 – 1)
= 15.66%
g3 = g1 + (g5 – g1) × (3 – 1) ÷ (5 – 1)
= 17.94% + (8.84% – 17.94%) × (3 – 1) ÷ (5 – 1)
= 13.39%
g4 = g1 + (g5 – g1) × (4 – 1) ÷ (5 – 1)
= 17.94% + (8.84% – 17.94%) × (4 – 1) ÷ (5 – 1)
= 11.11%