Investment Valuation in India

Elementary valuation theories focus on dividends as the base for valuing equity shares. It represents the cash flow to the shareholders which is discounted to arrive at the value of shares. However, not all companies distribute dividends and we us other valuation methods to value shares of companies which do not distribute dividends. However, consider this. Dividend theories suggest that if the company believes that reinvesting dividends would lead to better shareholder wealth maximisation, dividends should not be distributed but should be reinvested instead. Accordingly, generally in emerging economies such as India, dividends have a much lower impact on valuation as companies prefer to reinvest the profits or distribute only a small part of the profits to shareholders. This leads to better capital appreciation for the investors and leads to higher valuation for the companies – particularly when the markets are ‘bullish’. Dividend Payout Policies are sensitive for the companies ...

Gordon Model (Constant Growth rate) The Gordon model assumes a constant growth rate for infinity. The value of the stock is given by: V = D1 / (Re - g) Where, D1 = Expected dividend at the end of the year Re = Required rate of return on equity g = Expected growth rate for a long period of time (mathematically, infinite period) For example, A Ltd. Reported earnings per share (EPS) of Rs 15 last year and paid out 52% of its earnings as dividend. The earnings and dividends are expected to grow at the rate of 8% in the long term as in the past. If the required rate of return on equity shares of A Ltd. is 12%, the value of the security is calculated as follows; EPS = Rs 15 The Current dividend per share is given by the payout ratio times the EPS. Dividend per share (D0) = 15 x 0.52 = Rs. 7.8 So the expected dividend would be given by multiplying the current dividend with the expected growth rate. Dividend per share (D1) = 7.8 x 1.08 = Rs. 8.42 Expected growth rate = 8% Required rate of retu...

The term dividend refers to that part of after-tax profit which is distributed to the owners (shareholders) of the company. The undistributed part of the profit is known as Retained earnings. Higher the dividend payout, lower will be retained earnings. The dividend policy of a company refers to the views and policies of the management with respect of distribution of dividends. The dividend policy of a company should aim at shareholder-wealth maximization. The essence of dividend policy is: If the company is confident of generating more than market returns then only it should retain higher profits and pay less as dividends (or pay no dividends at all), as the shareholders can expect higher share prices based on higher RoI of the company. However, if the company is not confident of generating more than market returns, it should pay out more dividends (or 100% dividends). This is done for two reasons. One, the shareholders prefer early receipt of cash (liquidity preference theory) and sec...