Question

The company AT&T’s current stock price is $33.79, and yesterday it paid a dividend of $1.85 per share. Analysts expect the dividend to grow at an 8% rate for the next three years (i.e. the next three dividends) due to the continued market growth of smartphones and increased usage of data services. Beginning with the dividend in year 4, analysts expect AT&T’s dividend growth rate to level off to 3% in perpetuity as these two revenue streams mature and data prices come down. Assume a 15% discount rate for the below questions.

What is the expected dividend two years from today? Round to two decimal places, i.e. 1.23.   

Based on your analysis of AT&T’s forecasted dividends, what should today’s stock price be? Round to two decimal places.

Refer to your answer on the previous question. Using this analysis alone (without any outside qualitative or strategic analysis), would you recommend buying AT&T’s stock?

Yes, I recommend purchasing the stock because my analysis shows that the market undervalues the stock.

No, I recommend not purchasing the stock because my analysis shows that the market overvalues the stock.

Answer 1

We use the 'Multistage Dividend Discount Model' to arrive at the answer. After reading the question, you will realise that a Two-Stage Model is needed.

According to the question,

Current Stock Price (CSP) = 33.79$.

Discount Rate (K) = 15%

Yesterday's Dividend (D₀) = 1.85$.

First Stage:

Initially, the dividend grows at 8% for 3 years.

So, after 1 year , the dividend D₁= (1+0.08)*D₀

                                                 =(1.08)*1.85

                                                 =1.998 $.

After 2 years, the dividend becomes D₂ = (1+0.08)*D₁

                                                         =(1.08)* 1.998

                                                         =2.1578

                                                          =2.16 $ (rounding to 2 decimal places)

The Expected dividend 2 years from today is D₂= 2.16$.

After 3 years the dividend is (D₃)=(1+0.08)*D₂

                                               =(1.08)* 2.16

                                               = 2.33 $.

From year 4, the growth becomes 3%.

We need to take this into consideration. Because of this, D₃ will be modified slightly before we value the stock. We will see how the modification happens in the Second Stage of our calcualtions.

Second Stage:

From the 4th year, the dividend will grow at 3% forever.

After D₃, the subsequent dividends D₄,D_5,D₆, etc will each grow at a CAGR of 3% .

We find the resultant value of D₄,D_5,D₆, etc using the Gordon Growth Model.

According to Gordon Growth Model, if the initial dividend (d₀) grows at a constant rate of g% and the discount rate is K_e%,

Then the stock value

Since the 3% growth starts from year 4,

d₀=D₃= 2.33$.

V₀ is the valuation at the end of year 3. This will be added to D₃ in the final valuation.

g=3%.

K_e=15%.

V₀= 19.99 $.

This is the effective value at the end of year 3 .

Final Valuation using Multistage Dividend Discount Model:

Stock Price Valuation (P₀)=

P₀₌   1.737 + 1.633 + 1.532 + 13.143

P₀= 18.04 $                                      

Based on the forecasted dividends, the current price should be 18.04$.

The Current Stock Price (CSP) = 33.79$.

But the valuation is 18.04$. Hence, the Stock is overvalued.

I do not recommend purchasing this stock.