Forum Archive Index - May 2004

["tennyson@caverock.net.nz" <tennyson@caverock.net.nz>]

Hi Dean,

> 
>In regards to the DDM
> 

We are talking here about the 'dividend discount model', which is very 
suitable for looking at mature companies that pay good dividends.

>
>The reason I have used it is - as a minority shareholder my only
>return on the stock is dividends (and capital gain - but don't tell
>the taxman ;-)  ) so this is the relevant CF model for me for this
>stock. Also have considered WRI a fairly mature company so have 
used
>constant growth DDM -   D1/ r-g
> 

Where D1 is the dividend received in year 1.
r is the 'required rate of return'  (percent expressed as a fraction)
g is the expected constant growth in dividend payments stretching into 
the future on an annual basis (percent expressed as a fraction).

>
>To calculate my expected return on equity in the denominator have 
used
>CAPM - inputs for CAPM are: WRI beta 0.84, NZ market risk premium 
7.5%
>Used RFR of 5yr Treasury bond of 5.87% - as I'm a long term holder, 
>but you could
>use an earlier maturity if you were a short term holder or could also
> adjust the rate upward if you thought interest rates were on the rise.
> 
>To calculate growth rate in divs in the denominator could use
>historical div growth rate for WRI over the last ten years or so but I
>have used the implied growth rate rate from the sustainable growth
>model (g=RR*ROE) where RR is div retention rate.  This I believe 
gives
>WRI's true growth potential for the future rather than just using past
>rates.  Of course this gives a low growth rate but as WRI is not
>retaining much cash this would be a fair assumption.
>

The stated policy of WRI is to pay out 60-80% of dividends as 
earnings.   Lately they have been paying out closer to 80% so I will use 
the figure of only 20% of profits being retained.

ROE since the time that Freeth took over five years ago has averaged 
out at 10.9% (with some adjustment for one off items).

If for every $100 earned $20 is retained and that amount is used to 
grow earnings in the subsequent year, that means earnings growth will 
be $20 x 0.109= $2.18, or 2.18%.  This is the dividend growth rate 'g'.

We choose to take 'r' as the weighted average cost of capital.   For a 
company with no term debt (like WRI) , this is the same as the 
weighted average cost of equity, 're'.   

're'='rf'+ (beta)( E(rm)-'rf' )

Where 'rf' is the risk free rate of return, and
E(rm) is the expected rate of market return.

Again using your figures Dean I get

= 5.87%+ (0.84)( 7.5% - 5.87% )= 7.24%.

If I take this years core dividend of 2.5c + 6c= 8.5c as my starting 
point, then using the DDM model I get one WRI share to be worth:

= 8.5c/( 0.0724-0.0218 ) = $1.68

> 
>Calculate D1 in the numerator and 'Plug and play' gives a value of
>around $1.21.
>

That is quite different to the $1.68 I calculated above.     Are you able 
to reconcile your result with my calculation?

> 
>Of course I believe valuation is just a guess any way, really depends
>greatly on your input assumptions especially in the denominator 
Could
>just as easily use other assumptions that were equally as valid and
>get a totally different value.
>

Yes, very true.  Perhaps that explains the different result between your 
calculation and mine.

SNOOPY


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