Question

1. Compare the dividend discount model and the method of multiples. Under what circumstances does the dividend discount model make more sense? Under what circumstances does the method of multiples make more sense?

Answer 1

​​​​​​Comparison of Dividend discount model and the method of multiples

The Dividend discount model is the method of valuing a company's stock price while the multiples method is an approach to value a company with comparing with other.

The dividend discount model predicts the price of a company's stock and make assumptions about expected future dividends.The multiples predicts the value of a firm on the idea that similar assets sell at similar prices.

The basis used for the dividend discount model is the net present value of the future dividends.Whereby in the multiples method the value of a company is determined based on the value of another.

The assumption in dividend discount model is that the current fair price of a stock will equal the sum of all company's future dividends which is discounted to their present value,while the assumption behind the multiples approach is that a certain ratio is applicable and can be simplified across different companies.

The dividend discount model makes more sense to value the stock of companies with rapid growth rate as it states only future cash dividends can give consistent estimate of a company's value.The dividend discount model is on the principle that the value of a stock is computed on the basis of the relevant cash flow.

The multiples method makes more sense in order to make different companies more comparable,as it uses comparative multiples like price earnings .It makes comparison of companies using the similar financial metrics which makes this method more reliable.