Category: High Dividend Stocks

High Dividend StocksValue Investing Ideas

Dividend Discount Model, Pro Stock Analysis

Stock AnalysisThe Dividend Discount Model (Gordon Equation) calculates the intrinsic value of a stock based on the present value of a company’s future dividends. The model is a powerful investing tool to evaluate if a stock is over or undervalued compared to the market price. Professional investors use the Dividend Discount Model (among others) to value a stock, but for some reason casual investors have a habit of looking at a stock’s price chart to determine if a stock is a good value. The ill-fated chart approach has caused many casual investors to lose a bundle, after all – how can you profitably drive your portfolio if you’re focused on the rear view mirror?

This post is divided into the following sections: Dividend Discount Model’s equation, a sample valuation using Microsoft, and problems with the model.

The Dividend Discount Model

Where:

D1 (Estimate of next year’s dividend) = Current annual dividend * (1 + g)
r (Required Rate of Return for the Stock) = Real Risk Free Rate + (Market Return – Real Risk Free Rate) * Beta of Stock
Real Risk Free Rate = 52-Week T-Bill Yield**
Market Return = Estimate for the stock market’s return in the next year
g (Dividend Growth Rate) = Estimate for the stock’s dividend growth rate (you may calculate g by using the growth of the dividend in the past)

** 52-Week T-Bill Yield – You can find the yield by going to the U.S. Treasury Direct website, selecting the most recent year under auction date > 52-week bills > PDF of the latest auction results.

Sample Valuation

Here’s a sample valuation of Microsoft (MSFT) using the Dividend Discount Model..

The Dividend Discount Model requires two major assumptions – the return on the stock market for the next year and the growth rate for the stock’s dividend. In this example I will use an optimistic 12% expected return for the stock market, and a 10% dividend growth rate for Microsoft, based off their 2008 dividend growth. When you run the equation you can change these values to high, medium and low numbers, so that you can see a range of strike prices based on differing 1 year outcomes for the stock market and Microsoft’s dividends.

g (growth rate) = 2008 dividend / 2007 dividend
= .44/.40
= 10%
D1 = Current Dividend * (1 + g)
= $.52 * (1 + .1)
= $.572
r (required rate of return) = risk free rate + (market rate – risk free rate) * MSFT’s beta
= .55% + (12% – .55%) * 1.01
= 12.12%
Dividend Discount Model = D1 / (r – g)
= $.572 / (.1212 – .1)
= $26.98

Microsoft closing price as of last Friday July 24, 2009 was $23.45, so with a $26.98 valuation from the Dividend Discount Model, Microsoft would be considered undervalued.

Problems With the Model

For high-growth stocks, the growth rate (g) may be higher than the required rate of return (r), in which case the suggested stock value would be a negative number.

It is important not to use the Dividend Growth Model by itself, but rather as one tool in the value investing toolbox we’re constantly building on this blog

Feel free to ask me any questions you may have in the comments section below..

Verizon Stock Dividend
High Dividend StocksStock Tips

Verizon – Stocks That Can Defend High Dividends

In October, Verizon Communications (VZ) raised their quarterly dividend 7% to $.46 a share from $.43 cents, with a dividend yield at today’s price now 5.67%. Verizon should be able to defend its dividend in the next 12 months. The communications company is estimated to grow EPS 4% in the next four quarters, a slower rate than 2008’s 8%, but enough to cover the current dividend. The expected dividend payout ratio for 2009 is 69% percent of earnings, which is comfortably nested between the payout ratios from 2007 – 70% and 2008 – 67%. However, at today’s market price the company appears to be trading at a premium.

Verizon In The Bear Market

Two aspects of Verizon that I believe really help them in the current market conditions are their contract agreements and bundled services. The majority of Verizon Wireless customers are locked into a 2 year contract, with a steep termination fee of a couple hundred dollars, which will help retain customers through this recession. Secondly, Verizon has created a value bundle of their home product line that includes FIOS high speed internet, digital TV, and phone lines. Revenue for their bundled packages was up 45% year-over-year in the 3rd quarter reported in October. When families consider cutting their bills in these hard times, the Verizon package has strengthened its attraction.

Company Strengths

“Can you hear me now?” Verizon spent $2.5 billion on its successful advertising campaign in 2007, continuing to grow its already powerful brand name. 

Verizon has two product and service segments – wireline and domestic wireless that serve businesses and consumers.

The wireline segment was 54% of revenue in 2007 with sales of $50 billion and an above industry average 27.3% EBITDA profit margin. Wireline consists of voice, VOIP, internet access, and digital television. The segment has 41 million lines in 150 countries, with 85% of revenue comes from the United States. 

The wireless segment is run exclusively in the U.S. and in the most recent quarter Verizon added a net 2.1 million subscribers. The EBITDA profit margin for the wireless segment is 44.2%.

Company Risks

The two major risks for Verizon are cut-throat competition and the Telecommunications Act of 1996.

The company faces both solidified communications companies and cutting edge start-ups. Most notably, the company’s wireline phone services have to compete with low or zero cost voice-over-internet-providers like Vonage and the MagicJack which plugs into the a computer USB port and only costs about $20 a year.

The Telecommunications Act of 1996 permits competitors to buy Verizon’s services at a discount and resell them in the marketplace. This cuts into Verizon’s profit margins and ability to add subscribers. However, since the act was put into law in 1996 the company’s bottom line has risen tremendously, so you can make the case that the act has only a slight negative effect that hurts every company in the industry equally.

Additionally, Verizon has a unsettlingly low current ratio of .68 and debt-to-equity of .88. The firm clearly uses a lot of debt to aggressively grow earnings, and if they begin to lose market share from stiff competition their high leverage will backfire.

More Information on Verizon

You can visit http://investor.verizon.com/ to read Verizon’s latest quarterly and annual report.

Conclusion

Verizon is not poised to break any earnings growth records in 2009, but the company is competitively positioned with its bundled packages to fight this recession and retain past growth rates when we return to a bull market. I believe that if Benjamin Graham could comment, he would conclude that Verizon is not a value investment at today’s price of $32.47. The company does not meet the 2-1 current ratio requirment, nor is it trading 40% below its 52-week high. But, if you can buy shares between $25-$28 the company becomes much more attractive and you can benefit from a sturdy dividend yield between 6 and 7.5%.

Full disclosure: None.