Page 27 - FINAL CFA II SLIDES JUNE 2019 DAY 7
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LOS 29.j: Explain the growth phase, transition phase,
and maturity phase of a business. READING 29: DISCOUNTED DIVIDEND VALUATION
• An initial growth phase, rapidly increasing earnings, little or no dividends, and heavy reinvestment. MODULE 29.3: MULTIPERIOD MODELS
• A transition phase, earnings and dividends are still increasing but at a slower rate as competitive forces reduce profit opportunities and the need for reinvestment.
• A mature phase, earnings grow at a stable but slower rate, and payout ratios are stabilizing as reinvestment matches depreciation and asset maintenance requirements.
This pattern is not predestined
because many firms are successful
in constantly adapting and entering
into new growth opportunities.
Mature firms may develop
technology that forms the basis for
a whole new product and market.
The point is that a multistage
model is required in order to
value many firms. Fortunately,
the GGM is easily adaptable to
multistage growth.
LOS 29.k: Describe terminal value and explain alternative approaches to determining the terminal value in a DDM.
EXAMPLE: Estimating terminal value: Level Partners is expected to have earnings in ten years of $12 per share, a dividend payout ratio of 50%, and a
required return of 11%. At that time, the dividend growth rate is expected to fall to 4% in perpetuity, and the trailing P/E ratio is forecasted to be eight
times earnings. Estimate the terminal value at the end of ten years using the Gordon growth model and the P/E multiple.
The terminal value given forecasted earnings of $12 and a P/E ratio of 8 is:
terminal value in Year 10 (trailing P/E multiple) = $12.00 × 8 = $96.00
Many analysts also use market price multiples to estimate the terminal value rather than use the GGM method of discounting dividends. For example, we
could forecast earnings and a P/E ratio at the forecast horizon and then estimate the terminal value as the P/E multiplied by the earnings estimate.
Answer: The dividend at the end of ten years is expected to be $6 ($12 multiplied by 50%).
The dividend in Year 11 is then $6.00 × 1.04 = $6.24. The terminal value using the Gordon
growth model is therefore:
