Company XYZ paid the following dividends from year 1 to year

Company XYZ paid the following dividends from year 1 to year 5:

                1.50        1.58        1.58        1.58        1.66

(Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) Show work.

a)      Find dividend average growth

b)      Find the value of the stock assuming that: company will pay a constant dividend of 1.66 and that you require 15% return on the stock.

c)       Find the value of the stock assuming you require 15% return on the stock and assuming the dividend will grow at the rate you calculated in (a) (use constant growth model).

d)      Based on $75.58 closing price today and the values you calculated in part (b) or (c), should you purchase the stock at its current market price? Why or why not? Will you earn the 15% return?

e)      What is the return you would earn if you purchase the stock at $75.58? Use the growth rate in dividends you calculated in (a).

Solution

Definition of \'Dividend Growth Rate\' The annualized percentage rate of growth that a particular stock\'s dividend undergoes over a period of time. The time period included in the analysis can be of any interval desired, and is calculated by using the least squares method, or by simply taking a simple annualized figure over the time period. The dividend growth rate is necessary in order to use the dividend discount model, which is a security pricing model that assumes that a stock\'s price is determined by the estimated future dividends, discounted by the excess of internal growth over the firm\'s estimated dividend growth rate. A history of strong dividend growth could mean that future dividend growth is likely, which can signal long-term profitability for a given company. Definition of \'Value Stock\' A stock that tends to trade at a lower price relative to it\'s fundamentals (i.e. dividends, earnings, sales, etc.) and thus considered undervalued by a value investor. Common characteristics of such stocks include a high dividend yield, low price-to-book ratio and/or low price-to-earnings ratio.A value investor believes that the market isn\'t always efficient and that it\'s possible to find companies trading for less than they are worth. An easy way to attempt to find value stocks is to use the \"Dogs of the Dow\" investing strategy - buying of the 10 highest dividend-yielding stocks on the Dow Jones at the beginning of each year and adjusting it every year thereafter.