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Forum List » Value Ideas and Strategies Share and discuss value investing ideas and investing strategies. Dividend Discount Model Indicates a Buy for Potash Corporation
Posted by:
Victor Selva
(IP Logged) Date: April 16, 2014 05:05PM
Its P/E ratio indicates that the stock is relatively overvalued (17.1 vs 16.4 of industry mean). So now let's take a look at the intrinsic value of this company and try to explain to investors the reasons why it is a good buy or not. In this article, we present a model that is by no means the be-all and end-all for valuation. The purpose is to force investors to evaluate different assumptions about growth and future prospects.
In stock valuation models, dividend discount models (DDM) define cash flow as the dividends to be received by the shareholders. Extending the period indefinitely, the fundamental value of the stock is the present value of an infinite stream of dividends according to John Burr Williams. Although this is theoretically correct, it requires forecasting dividends for many periods, so we can use some growth models like: Gordon (constant) growth model, the Two or Three stage growth model or the H-Model (which is a special case of a two-stage model). To start with, the Let´s estimate the inputs for modeling:
The capital asset pricing model (CAPM) estimates the required return on equity using the following formula:
rPOT = RF + βPOT [GGM ERP] = 2.67% + 0.99 [11.43%]
The sustainable growth rate is the rate at which earnings and dividends can grow indefinitely assuming that the firm´s debt-to-equity ratio is unchanged and it doesn´t issue new equity.
b = retention rate ROE can be estimated using Dupont formula: Because for most companies, the GGM is unrealistic, let´s consider the H-Model which assumes a growth rate that starts high and then declines linearly over the high growth stage, until it reverts to the long-run rate, a smoother transition to the mature phase growth rate that is more realistic.
With the GGM formula and simple math: The growth rates are:
G(2), g(3) and g(4) are calculated using linear interpolation between g(1) and g(5).
When the stock price is lower than the intrinsic value, the stock is said to be undervalued and it makes sense to buy the stock. We have covered just one valuation method and investors should not be relied on alone in order to determine a fair (over/under) value for a potential investment. Hedge fund gurus have also been active in the company. Gurus like Murray Stahl (Trades, Portfolio), Paul Tudor Jones (Trades, Portfolio), Louis Moore Bacon (Trades, Portfolio), David Dreman (Trades, Portfolio) and Arnold Van Den Berg (Trades, Portfolio) have bought the stock in fourth quarter of 2013.
[1] This values where obtained from Blommberg´s CRP function. Guru Discussed:
Arnold Van Den Berg:
Current Portfolio,
Stock Picks David Dreman: Current Portfolio, Stock Picks Stocks Discussed: POT,
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