I need to know the formula for EM. I think it’s Earnings model. I’m not sure. But I really need that formula. And also if anyone knows the Dividend Discount Model. Thanks, you’re help will be greatly appreciated.
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Yeah just type in dividend discount model at wikipedia. They have a really good example. However the theory is you are determining the value of the company’s dividends today, whether they are paid today or paid later on.
Obviously if someone said they will give you $1,0 right now, that’s great news! But if they said they would give you $1,0 45 years from now, you are not as excited about it. This phenomenon is called the time value of money.
Dividend discount method tries to incorporate the time value of money into dividend checks. So if you know that a company will pay $5 this year in dividends, $6 two years from now, $7 the next year and so on you can figure out (using the time value of money) what the total value of all of those dividend payments given to you in the future are.
The way you do this is by discounting those future payments based on when you will receive them by an interest rate that you could get elsewhere.
So if you will get $5 a year from now, but you could earn 10% interest on that $5 if you had it now, then $5 now would actually be worth $5.50 in a year if you could receive it now. But you aren’t going to receive it now, you will receive it in one year. So that $5 will be worth less in one year. How much less?
PV = FV / (1 + i) ^ n
PV is present value (what we want to know)
FV is future value (the $5)
i is interest rate (10% in this case)
n is the number of years (1 year in this case)
PV = 5 / (1 + 0.1) ^ 1
PV = $4.54
So the value of this dividend payment one year from now is $4.54. According to the dividend discount method then, if you want to figure out what dividend portion of a stock is worth, figure out what the dividends will be next year, the year after that, the 3rd year, and so on. Then calculate the present value of each of those payments and add all of them up. Then you will have how many dollars you should pay for the stock! (I disagree with the dividend discount method though, there is more to a stock’s value than just what it pays/will pay in dividends).
PV = FV X (1 + i) ^ n
Discount the value of the future anticipated dividends to present value; that is the dividends discount model. The earnings models works the same except you use the discounted projected earnings.