Question

How do the two articles below address the dividend discount model and show changes from original estimations to later estimations based on first quarter results? Any analysis of these two articles would be greatly appreciated so I may better understand the DDM.

The first article was written in April of 2018 and the second was written in July 2018.

April 2018 Article: https://seekingalpha.com/article/4166249-mcdonalds-corporation-target-price-147-according-dividend-discount-model

July 2018 Article: https://seekingalpha.com/article/4189029-mcdonalds-current-valuation-view?page=2

Answer 1

The analyst or writer of the articles has not really used DDM model. What he has done is calculate a target P/E ratio for the company, then estimate EPS or Earnings per share till 5 years. The EPS is then multiplied by P/E to give a target price on which the present value of dividends in 5 years is added.

He did the last step because the price of the stock falls by the dividend whenever it is declared. This method involves forecasting both earnings and dividends.

Let me show you an example of the actual DDM model.

The DDM model assumes that the intrinsic value or the price of a share of a company comes only from the present value of future dividends.

https://in.finance.yahoo.com/quote/MCD/key-statistics?p=MCD

The trailing value of dividends for Mcdonalds is $3.9 per share, and morningstar has estimated the forward value to be $4.04, a growth rate of around 3.6%

Price = D1 / (r-g)

where D1 = dividends in next period, r = discount rate, g = growth rate

Assuming discount rate of 7% and growth rate to be maintained at 3.6%,

Price = 4.04 / (7%-3.6%) = $118.82 per share

Since the price is much lower than current price, probably a higher dividend growth in future is actually expected by investors (or the share is actually overvalued).

Another method can be to first estimate future earnings (EPS) of the company, apply a target payout ratio (check if it has historically remained same for the company) and obtain the future dividends and then discount them to find the price.

Leave a comment in case of any doubt, i'll try to clear it.