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Does dividend affects valuation
21-10-2019, 02:01 PM.
Post: #1
Does dividend affects valuation
Just want to get some discussion on this topic. I have been thinking about whether dividend affects valuation.

Theoretically, dividend doesn't affect valuation. Since valuation comes from all the future free cash flow a business, that is, free cash flow after including maintenance capex. Since dividend comes after free cash flow, as part of the capital allocation decision of the business on the ratio between dividend, reinvestment, buyback etc, so whether a company pays dividend or not does not affect valuation such as DCF. And this is the classical textbook case of valuation. 

On the other hand, dividend does affect valuation because of time value of money. If a company that never pays any dividend suddenly announce a special dividend tomorrow due to some divestments, market is going to 'value' the stock a lot more than if nothing has been paid out. This make sense because the cash receive today is worth more than one received tomorrow. And in most cases, high dividend paying stocks have been valued based on their dividends i.e dividend growth model. And it also seems to be the case that dividend paying stocks are seen more 'favourable' than one that doesn't pay anything. 

Any thoughts? Or both are correct?

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21-10-2019, 07:38 PM. (This post was last modified: 21-10-2019, 07:39 PM by Ray168.)
Post: #2
RE: Does dividend affects valuation
(21-10-2019, 02:01 PM)RJT Wrote: Just want to get some discussion on this topic. I have been thinking about whether dividend affects valuation.

Theoretically, dividend doesn't affect valuation. Since valuation comes from all the future free cash flow a business, that is, free cash flow after including maintenance capex. Since dividend comes after free cash flow, as part of the capital allocation decision of the business on the ratio between dividend, reinvestment, buyback etc, so whether a company pays dividend or not does not affect valuation such as DCF. And this is the classical textbook case of valuation. 

On the other hand, dividend does affect valuation because of time value of money. If a company that never pays any dividend suddenly announce a special dividend tomorrow due to some divestments, market is going to 'value' the stock a lot more than if nothing has been paid out. This make sense because the cash receive today is worth more than one received tomorrow. And in most cases, high dividend paying stocks have been valued based on their dividends i.e dividend growth model. And it also seems to be the case that dividend paying stocks are seen more 'favourable' than one that doesn't pay anything. 

Any thoughts? Or both are correct?

Dividend has direct relationship with valuation.

https://www.investopedia.com/terms/d/ddm.asp

https://www.youtube.com/watch?v=7T8sgT-otDU

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21-10-2019, 09:44 PM.
Post: #3
RE: Does dividend affects valuation
Dividends affects valuation. A good example are Developers trading at discount and REITs trading at NAV or above NAV. (Developer is trading at discount and holds an asset to be sold to REIT. After Developer sell the reit asset to REIT, the full value of asset will be reflected in price of REIT.)

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22-10-2019, 07:01 AM.
Post: #4
RE: Does dividend affects valuation
(21-10-2019, 07:38 PM)Ray168 Wrote:
(21-10-2019, 02:01 PM)RJT Wrote: Just want to get some discussion on this topic. I have been thinking about whether dividend affects valuation.

Theoretically, dividend doesn't affect valuation. Since valuation comes from all the future free cash flow a business, that is, free cash flow after including maintenance capex. Since dividend comes after free cash flow, as part of the capital allocation decision of the business on the ratio between dividend, reinvestment, buyback etc, so whether a company pays dividend or not does not affect valuation such as DCF. And this is the classical textbook case of valuation. 

On the other hand, dividend does affect valuation because of time value of money. If a company that never pays any dividend suddenly announce a special dividend tomorrow due to some divestments, market is going to 'value' the stock a lot more than if nothing has been paid out. This make sense because the cash receive today is worth more than one received tomorrow. And in most cases, high dividend paying stocks have been valued based on their dividends i.e dividend growth model. And it also seems to be the case that dividend paying stocks are seen more 'favourable' than one that doesn't pay anything. 

Any thoughts? Or both are correct?

Dividend has direct relationship with valuation.

https://www.investopedia.com/terms/d/ddm.asp

https://www.youtube.com/watch?v=7T8sgT-otDU

I know it affects valuation in DDM, but how does one reconcile with the fact that valuation method like DCF doesn't have any relationship?

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22-10-2019, 07:51 AM.
Post: #5
Rainbow  valuation using DDM vs DCF?
Thanks valuebuddies RJT for yet another excellent posts.

I benefited tremendously from your writing.
You had the strong appetite to digest a wide range of materials.
You're able to condense and arrange them in an excellent post as summary.

Thank you very much.



I must confess that I'm not able to perform valuation of a company to my own satisfaction.

I learn that different company/industry/situation will require different valuation methods to evaluate the business potential.

If our objectives is to evaluate a business based on dividend, then DDM should be the appropriate tools.

In another situation, DCF will be a better tools.

Of course, all these tools are freely available in our toolbox for measurement.
What we want to measure, we will need to use the appropriate tool(s) accordingly.


Now, that's the easy part.
The difficulties that I face is most of the tools does not really yield the results that I wanted.
I felt that the result of these measurement either is already reflected in current stock price or in some cases a stock price that I couldn't believed.
The fact is, most of the time, my trading decision does not depends on the DDM/DCF/etc, as the market price is roughly the calculated price.
In other words, without using any of the tools, a glanced on current Qtr and AR will gives me enough clue to stop investigation on a lousy stock or continue to dig further on whether it's a potential gem.


From my current holding, I'm pretty surprised that most of the exhibit the growing dividend trends.
I can't be sure whether I deliberately choose them or not.

#1 Micro-Mechanics since 2009: 1.14% 1.70% 2.84% 3.41% 4.55% 5.68%

#2 Straco since 2007:  0.34% 0.52% 0.69% 1.03% 1.72% 2.76% 3.45% 4.83%

#3 iFast since 2015:  2.72% 2.79% 2.86% 3.15% 

and this one is our valuebuddies favorite
A born-again young Penguin since 2016: 0.37% 0.67% 1.85%


With this, my dear friend, enjoy Joker Xue


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感恩


Most of the time, my buy/sell decision does not depends so much on the DDM/DCF/etc but

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22-10-2019, 08:59 AM.
Post: #6
RE: Does dividend affects valuation
TLDR: dividends affect valuation, but in nuanced ways.

1. To your question, dividend payouts do affect future FCFs in an indirect way, at least in theory. Growth of a firm is loosely generalized as the interaction between a return measure (e.g. ROE, ROIC, ROA, ROIIC etc) and capital retained (e.g. profits less dividends paid). At least in theory, if a firm chooses to pay more dividends today, it implies a lack of profitable (NPV positive) projects to invest in. Returning more capital back to shareholders as opposed to retaining the capital to drive growth will lead to reduced FCF in the future. Obviously, this does not apply if the firm is extremely capital light, and do not require capital to grow

2. Closely related to point 1, dividend payout policy provides investors with an idea on the capital allocation competencies of the management, which in turn affects the valuation multiple one is willing to pay. E.g. if I see a firm operating in a structurally declining industry with few profitable investment projects, I expect the firm to be proactive in returning capital back to shareholders. If instead the firm chooses to reinvest the capital in low return projects, it's actually destroying shareholder value in the long run. Such firms will be penalized in the form of a lower valuation multiple

3. Dividends have clientele effect. Some institutional investors (think income funds) can only invest in firms that pay high and stable dividends etc. Also, some retail investors (especially Asians or the aged) have a preference for high yielding stocks. Further, certain funds take a top down investing view, tending towards high dividend yielding defensive stocks when the environment is uncertain.The flow from such investors will drive up the valuations

4. Finally, for some firms, dividend payout does affect the perceived riskiness of the firm, which in turn affects the discount rates used to discount project cash flows. E.g., if you have a cash-rich S-chip that's showing strong earnings year in year out, but does not pay a single cent of dividends, cynical investors may justifiably suspect the veracity of the accounts. In such instances, the S-chip can allay concerns significantly by paying out consistent dividends, which will help reduce the perceived riskiness and discount rates.

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22-10-2019, 01:42 PM. (This post was last modified: 22-10-2019, 04:23 PM by specuvestor.)
Post: #7
RE: Does dividend affects valuation
(22-10-2019, 07:01 AM)RJT Wrote:
(21-10-2019, 07:38 PM)Ray168 Wrote:
(21-10-2019, 02:01 PM)RJT Wrote: Just want to get some discussion on this topic. I have been thinking about whether dividend affects valuation.

Theoretically, dividend doesn't affect valuation. Since valuation comes from all the future free cash flow a business, that is, free cash flow after including maintenance capex. Since dividend comes after free cash flow, as part of the capital allocation decision of the business on the ratio between dividend, reinvestment, buyback etc, so whether a company pays dividend or not does not affect valuation such as DCF. And this is the classical textbook case of valuation. 

On the other hand, dividend does affect valuation because of time value of money. If a company that never pays any dividend suddenly announce a special dividend tomorrow due to some divestments, market is going to 'value' the stock a lot more than if nothing has been paid out. This make sense because the cash receive today is worth more than one received tomorrow. And in most cases, high dividend paying stocks have been valued based on their dividends i.e dividend growth model. And it also seems to be the case that dividend paying stocks are seen more 'favourable' than one that doesn't pay anything. 

Any thoughts? Or both are correct?

Dividend has direct relationship with valuation.

https://www.investopedia.com/terms/d/ddm.asp

https://www.youtube.com/watch?v=7T8sgT-otDU

I know it affects valuation in DDM, but how does one reconcile with the fact that valuation method like DCF doesn't have any relationship?
My 2cents:
https://www.valuebuddies.com/thread-9368...#pid153162
(21-06-2019, 01:06 PM)specuvestor Wrote: So if a company with Book $100 say $10 annual net cashflow pass through issues 50 X shares with 100% pass through dividend and 50 Y shares with 100% retained dividend, which one will we buy determines what type of investors we are. For the former, 10 years later the X shares will be worth say same $50 but investors hold $50 cash, while the latter holds $100 worth of Y shares. The former can use the $50 cashflow to invest in other opportunities whereas the latter will have to sell his stake to realise the cashflow. So imagine the latter wants to have the same amount of $50 cash for whatevewr purpose he will have to sell 25 Y shares say to investors in X. So investors in X shares will have 50 X shares & 25 Y shares while investor in Y shares hold 25 Y shares. Their net worth is the same at this point but from there it will start to diverge. Just a simplified story. 

2 things we can also observe in real life 1) paying out cash before IPO give the owner better return and better valuation of the listco and 2) shell company with pure cash after selling core biz trades at about 10-20% discount.

I'll say Mr market believes in bird in hand better than 2 in bush. ability to pay cash also reduces counterparty risk rather than saying you have how much in the bank but can't pay out

DCF works if there is no Structure layer ie everything is paid out. Otherwise one will have to add a discount to that DCF cause OPMI has no control of that CF
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Before you speak, listen. Before you write, think. Before you spend, earn. Before you invest, investigate. Before you criticize, wait. Before you pray, forgive. Before you quit, try. Before you retire, save. Before you die, give. –William A. Ward

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24-10-2019, 08:37 AM. (This post was last modified: 24-10-2019, 08:46 AM by karlmarx.)
Post: #8
RE: Does dividend affects valuation
The pricing of investment products are similar to products from other categories.

The pricing of most products in a category are based on well established value proposition; paracetamol pills which cost a dollar or so and will cure my headache. On the other hand, the pricing of a small number of products in that same category are based on exaggerated-yet-unverified claims; this latest pill costs $8,000 and my experiments show it can possibly cure your headaches forever.

How an investment product is priced thus depends on how investors think/believe the stock will eventually reward them.

If they believe that the company is capable of growing the stock price, they will gladly accept not having dividends. Like Berkshire Hathaway, which pays no dividends, but has a share buyback policy pegged to NAV. Because WB has been keeping to his SBB policy for many year, BH investors are affirmed that as BH's NAV increase, so will the stock's price.

This also applies to the tech companies -- which have a very poor record of paying dividends -- where investors believe that said tech company will grow to dominate the specific market they are operating in. And perhaps at some later time, when the market has matured, begin to distribute dividends. Whether these tech companies succeed in their market, and eventually pay dividends, or not, is besides the point. It is investors' belief/hope/expectation that will drive valuation.

But few companies that opt not to pay dividends are spared backlash from the investing public. BH and most of the tech companies are the exception rather than the rule.

For the rest of the companies on the market -- which have not gained the trust/faith of the investing public to retain their earnings in exchange for extraordinary gains -- investors will demand a dividend payout, and will value them according to how much they pay.

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24-10-2019, 05:59 PM. (This post was last modified: 24-10-2019, 06:00 PM by specuvestor.)
Post: #9
RE: Does dividend affects valuation
yes "exception rather than the rule". One has to trust that the company can deliver better ROIC than one's opportunity cost, being other stocks or FD. The trust can be fickle or imaginary until the rubber hits the road. Applies to growth stocks or simply pre- IPO VC
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Before you speak, listen. Before you write, think. Before you spend, earn. Before you invest, investigate. Before you criticize, wait. Before you pray, forgive. Before you quit, try. Before you retire, save. Before you die, give. –William A. Ward

Think Asset-Business-Structure (ABS)

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