Question

Explain the difference between using the zero-growth dividend valuation model and the constant-growth dividend valuation model when finding the intrinsic value of common stock and preferred stock.

How does adding a growth rate to the valuation process affect the intrinsic value?

Answer 1

• The primary difference between a constant and non-constant growth dividend model is the perspective on future growth. A constant growth model assumes that growth rates will stay largely identical in the future to where they are now, while a non-constant growth model believes that these rates can change at any point.
• Nonconstant growth models assume the value will fluctuate over time. You may find that the stock will stay the same for the next few years, for instance, but jump or plunge in value in a few years after that. In that case, you can calculate for steady growth for those early years, then estimate upward or downward movement at whatever point you see necessary.
• As with constant growth, one way to lay out your calculation is to look at past performance. If the fluctuations were random, it can be far more difficult to try to predict them moving forward.
• Intrinsic value refers to some fundamental, objective value contained in an object, asset, or financial contract. If the market price is below that value it may be a good buy, and if above a good sale.