Question

3. In the table below you can find the earnings per share (EPS) and dividend per share (DPS) information for General Electric (GE) and General Motors (GM). For each company, please explain whether it is appropriate to use DDM to value the stock. (3 points)

Year   Company   EPS($)   DPS ($)
2001   GENERAL ELECTRIC CO   1.38   0.64
2002   GENERAL ELECTRIC CO   1.42   0.72
2003   GENERAL ELECTRIC CO   1.5   0.76

2004   GENERAL ELECTRIC CO   1.62   0.8
2005   GENERAL ELECTRIC CO   1.58   0.88
2006   GENERAL ELECTRIC CO   2.01   1
2007   GENERAL ELECTRIC CO   2.18   1.12

Year   Company   EPS($)   DPS ($)
2001   GENERAL MOTORS CO   1.78   2
2002   GENERAL MOTORS CO   3.37   2
2003   GENERAL MOTORS CO   7.24   2
2004   GENERAL MOTORS CO   4.97   2
2005   GENERAL MOTORS CO   -18.69   2
2006   GENERAL MOTORS CO   -3.5   1
2007   GENERAL MOTORS CO   -68.45   1

Answer 1

1. Dividend Discount Model (DDM) is constant growth model .
2. Formula for Share price valuation = Next year Dividend (D₁)/(K_{​​​​​​e}​​​​​- growth rate)
3. Hereif the Dividend growth rate for stocks being evaluated is greater than the rate of return (K_e), the share price would become negative ,which is not acceptable.
4. Companies often maintain to payout a constant or stable dividend even if there is a large variation of earnings. Some may even borrow money to pay their dividends to maintain their status as a regular dividend provider. If a business does not have their earnings directly tied to their income, then this valuation method becomes worthless.
5. Here, as far as General electric Co is concerned, it's stock price can be valued using Dividend Discount Model( DDM ) Provided growth rate of dividend can be easily anticipated and earnings and dividend have a constant growth as anticipated and the rate of return is greater than growth rate of dividend.
6. In light of third and fourth points above, as far as General Motors Co is concerned, it's stock price cannot be valued using Dividend Discount Model ( DDM) , as it's earnings have a large variation and even become negative in year 2005, 2006 and 2007 and would result in negative pricing of shares during those years which is not practical.