What future return can you get for investing into Public Bank Berhad?

We should keep our investing very simple and readily understandable.

Public Bank Berhad is a strong bank in Malaysia. Banking sector is highly regulated. Public Bank Berhad has done very well for decades building its banking business in Malaysia and increasingly in our neighbouring emerging countries. The challenge going forward is how well it adopts to new financial environment, in particular, that of fintech.

Its revenues, profits before tax and earnings per share have grown consistently over the last decade. It is this consistency and growth that confer to this company its high investment qualities.

It has also been distributing dividends regularly. Dividends have grown over the years (dividend growth investing). In the previous decade, it paid a higher dividend paid out relative to its earnings. It is presently paying out about 44% of earnings as dividends. It retained about 56% of its earnings in recent years. Its return on equity for the last 5 years averaged around 16.7%, which is remarkable. As an investor, I am happy that Public Bank Berhad is able to generate this high level of return on its equity. Its dividend payout ratio has declined in recent years due to its need to retain and build up its equity base in keeping with new Basel capital adequacy ratio guidelines.

It is a very well managed bank. It has been growing its net interest income and non-interest income satisfactorily without taking undue or too high risk.

At its present price of $19.98 per share, how attractive is Public Bank Berhad as an investment for the long term? Long term is taken to mean a period of at least 5 or 10 years.

Here are some facts and my opinion on Public Bank Berhad below.

1. At 19.98, it is trading at a PE ratio of 14.90.

2. It is trading at its fair price (neither undervalued or overvalued).

3. Its reward:risk ratio (based on my own method) is 6.84:1 (the probability risk of losing money is low and the reward: risk ratio is in your favour).

4. At the present price, assuming its future consistent growth in earnings per share of 6% per year (very conservative), this company can be expected to give about 13.07% simple average annual total return (= Annual capital appreciation of 9.62% and Average annual dividend yield of 3.45%) or 10% compound annual total return over the next 5 years.

5. At the present price of $19.98 and last FY dividend of 58 sen, its present Dividend Yield is 2.89%. Assuming its earnings and dividends grow consistently at 6% annually the next 5 years, we can expect a back of the envelop calculation return of approximately 2.89% + 6% = 9% annually (simple average). At such a conservative assumption in our calculation, this company may well surprise on the upside, making its investors happier.

I sought a higher return of 15% per year. This illustration shows that to get a return of 8% to 10% in the stock market or a stock, is actually quite achievable. To get a higher return, is more challenging than most realise.


Good luck in your investing.



Additional Notes:

Intrinsic value or Price
= Dividend / (required rate of return - growth)
= D / (r-g)

P = D / (r-g)
r-g = D / P
r = (D/P) + g
r = (Dividend Yield) + g

If you invest into a company that grows dividends at a constant rate of g, your expected return can be easily worked out as:

r = (Dividend Yield) + g

The present DY of Public Bank Berhad is 2.89%.

Our assumption is its dividend will grow at 6% per year.

Therefore, we can hope for a return of 2.89% + 6% = 8.89% or 9% per year.

Public Bank Berhad's last financial year dividend of 58 sen can support a share price of $16.25.


[Disclaimer:  Please do your own diligent analysis before investing.  Your investing should be based on your own analysis and informed decision.  This is not a recommendation.  You invest at your own risk.]

Return on Share Investment = Dividend Yield + Growth over Time (Gordon Growth Model)

Rearranging the Dividend Discount Model (DDM) formula:

PV = D1 / (k-g)

k = (D1/PV) + g
   = Dividend yield + growth over time.

This expression for the cost of equity (required rate of return) tells us that the return on an equity investment has two components:

• The dividend yield (D1/PV at year 0)
• Growth over time (g)

Return on share investment = Dividend Yield + Growth over Time:

Dividend Yield Investing

As deposit accounts pay very low interests or next to nothing, dividends on shares seem attractive. But you'll need to choose carefully.

Many large companies pay decent dividends once, twice or even four times a year. The yield – the dividend expressed as a percentage of the share price – is often attractive by comparison with interest rates on savings. There are now a wide range of blue chip companies yielding 4pc.



Warnings for those seeking Dividend Yield in their investing

When comparing a dividend yield with the interest rate on a savings account, however, certain warnings should be borne in mind.

1. The first point is that your capital is not guaranteed; share prices can and do fall.

2. Secondly, dividends can be cut drastically or axed altogether with little or no notice – and this can lead to a fall in the share price as well.


So just buying the shares with the highest dividend, without researching how safe that dividend is, can be a mistake.

There are now a huge range of high yielding blue chips but it is best to look for a dividend that is less likely to be cut even if that company's profits fall.

A high yield alone is not synonymous with a decent dividend.

If you carry out thorough research and pick the right shares, you will get better value for your cash than by leaving it in a savings account.



Measure of a dividend's reliability is Dividend Cover

The long-established measure of a dividend's reliability is dividend cover: the ratio of net profits to the size of the dividend payout.

Generally, a cover ratio of at least two – meaning that the company has twice as much net earnings as the amount earmarked for dividend payments – is considered a strong indicator.

Once again, for those who invest for yield or income - either Dividend Yield Investing or Dividend Growth Investing - STOCK SELECTION is still the key.

Search out for those companies that have a good chance of sustaining or even increasing their dividends.

If you are knowledgeable, you can even anticipate and avoid those companies that may skip or reduce their dividends in the future.




Stock selection is the key to dividend yield investing.

Some investors look at historic yields; some at forecast (or "prospective") yields.

But either way, those yields can be unexploded mines, lurking for the unwary.

Looking at yield on its own, in short, can quickly introduce you -- painfully -- to the meaning of the term "yield trap".



Yield Trap

The yield trap is simply explained.

You buy a share, attracted by the high yield. But the dividend is then cut, or cancelled -- leaving you without the anticipated income. Worse, unsupported by the payout, the share price usually falls as well, leaving you also nursing a capital loss.


Let's see it in action.

Company A pays out 9 pence a share, with shares changing hands for 100 pence per share. So the dividend yield -- which is the dividend per share, divided by the share price, and multiplied by a hundred to turn it into a percentage -- is 9%.

But that 9 pence is unsustainable. Company A then halves its dividend, slashing investors' income. What happens to the yield? If the share drops to -- say -- 80 pence, the historic yield the becomes 5.6%. The "yield on cost" figure, of course, is 4.5%.



How, then, should investors spot potential yield traps?  Answer:  Dividend cover

The most obvious reason for slashing the dividend is that the business simply hasn't got the money to pay it.

The business's earnings, in short, aren't large enough to support a distribution to shareholders at historic levels.

Put another way, actual earnings per share aren't sufficiently large when compared to the anticipated dividend per share.

Which is where the notion of 'dividend cover' comes in: earnings per share divided by dividend per share.



Interpret Dividend Cover with care

Now, dividend cover shouldn't be followed blindly.

Some businesses -- such as utilities, for instance -- can quite happily operate with lower levels of dividend cover than more cyclical businesses.

Other businesses -- such as REITs -- must pay out a fixed proportion of earnings as dividends, so again a low level of dividend cover is the norm.

Still other businesses have very high levels of dividend cover, because they are growing -- and therefore retaining earnings for future investment -- rather than paying them out as dividends.

But as a broad brush generalisation,

- A ratio of close to one is definitely the danger zone.
- A ratio much bigger than two indicates a certain parsimony.
- A ratio of 1.5-2.5 is usually what I'm looking for.



Stock Performance Guide on Dividends (by Neoh Soon Kean)

He considers dividend per share (DPS) as the most important factor when evaluating the worth of a share.

The ideal situation is for the DPS of a company to grow smoothly and rapidly over the years. (This is the Dividend Growth Investing I mentioned).

The DPS track record should be unbroken for many years.

One important caveat: you must compare the amount of dividend paid with the amount of earnings per share (EPS). (This is the dividend payout ratio).

- The growth of DPS must be proportionate to the growth of EPS.

- A company cannot sustain year after year of higher DPS thanEPS.

- On the other hand, the DPS should not be too small compared with the EPS unless the EPS is growing rapidly.

He advises, under normal circumstances, the DPS should be between 30% to 70% of the EPS.



Happy Investing

A practical analysis of dividend

A Practical Analysis Of Unilever Plc's Dividend

By Royston Wild | Fool.co.uk

The ability to calculate the reliability of dividends is absolutely crucial for investors, not only for evaluating the income generated from your portfolio, but also to avoid a share-price collapse from stocks where payouts are slashed.

There are a variety of ways to judge future dividends, and today I am looking at Unilever (NYSE: UL - news) to see whether the firm looks a safe bet to produce dependable payouts.

Forward dividend cover

Forward dividend cover is one of the most simple ways to evaluate future payouts, as the ratio reveals how many times the projected dividend per share is covered by earnings per share. It can be calculated using the following formula:

Forward earnings per share ÷ forward dividend per share

Unilever is expected to provide a dividend of 88.8p per share in 2013, according to City numbers, with earnings per share predicted to register at 139.1p. The widely-regarded safety benchmark for dividend cover is set at 2 times prospective earnings, but Unilever falls short of this measure at 1.6 times.

Free cash flow

Free cash flow is essentially how much cash has been generated after all costs and can often differ from reported profits. Theoretically, a company generating shedloads of cash is in a better position to reward stakeholders with plump dividends. The figure can be calculated by the following calculation:

Operating profit + depreciation & amortisation - tax - capital expenditure - working capital increase

Free cash flow increased to €5.14bn in 2012, up from €3.69bn in 2011. This was mainly helped by an upswing in operating profit -- this advanced to €7bn last year from ?6.43bn in 2011 -- and a vast improvement in working capital.

Financial gearing

This ratio is used to gauge the level debt a company carries. Simply put, the higher the amount, the more difficult it may be to generate lucrative dividends for shareholders. It can be calculated using the following calculation:

Short- and long-term debts + pension liabilities - cash & cash equivalents

___________________________________________________________            x 100

                                      Shareholder funds

Unilever's gearing ratio for 2012 came in at 56.6%, down from 59.5% in the previous 12 months. The firm was helped by a decline in net debt, to €7.36bn from €8.78bn, even though pension liabilities edged higher. Even a large decline in cash and cash equivalents, to €2.47bn from €3.48bn, failed to derail the year-on-year improvement.

Buybacks and other spare cash

Here, I'm looking at the amount of cash recently spent on share buybacks, repayments of debt and other activities that suggest the company may in future have more cash to spend on dividends.

Unilever does not currently operate a share repurchase programme, although it remains open to committing capital to expand its operations around the globe. Indeed, the company is attempting to ratchet onto excellent growth in developing regions as consumer spending in the West stagnates -- the firm saw emerging market sales rise 10.4% in quarter one versus a 1.9% fall in developed regions.

The firm remains dogged in its attempts to acquire a 75% stake in India's Hindustan Unilever (BSE: HUL.BO - news) , for example, and I expect further activity to materialise in the near future. Meanwhile, Unilever is looking to reduce its exposure to stagnating markets by divesting assets, exemplified by the recent sale of its US frozen foods business.

An appetising long-term pick

Unilever's projected dividend yield for 2013 is bang in line with the FTSE 100 (FTSE: ^FTSE - news) average of 3.3%. So for those seeking above-par dividend returns for the near-term, better prospects can be found elsewhere. Still, the above metrics suggest that the firm's financial position is solid enough to support continued annual dividend growth.

And I believe that Unilever is in a strong position to grow earnings strongly, and with it shareholder payouts, further out. Galloping trade in developing markets, helped by the strength of its brands -- the company currently boasts 14 '€1 billion brands' across the consumer goods and food sectors -- should significantly bolster sales growth and thus dividend potential in my opinion.

Tune in to hot stocks growth

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Our "Ten Steps To Making A Million In The Market" report highlights how fast-growth small-caps and beaten-down bargains are all fertile candidates to produce ten-fold returns. Click here to enjoy this exclusive 'wealth report' -- it's 100% free and comes with no obligation.

> Royston does not own shares in Unilever. The Motley Fool has recommended shares in Unilever.

http://uk.finance.yahoo.com/news/practical-analysis-unilever-plcs-dividend-090040474.html

Corporate Finance - Earning Growth Rate and Dividend Growth Rate

 Calculating a Company's Implied Dividend Growth Rate

Recall that a company's ROE is equal to a company's earnings growth rate (g) divided by one minus a company's payout rate (p).

Example:Let's assume Newco's ROE is 10% and the company pays out roughly 20% of its earnings in the form of a dividend. What is Newco's expected growth rate in earnings?

Answer:g = ROE*(1 - p)
g = (10%)*(1 - 20%)
g = (10%)*(0.8)
g = 8%

Given an ROE of 10% and a dividend payout of 20%, Newco's expected growth rate in earnings is 8%.

Read more: http://www.investopedia.com/exam-guide/cfa-level-1/corporate-finance/dividend-growth-changing-dividend-policy-effects.asp#ixzz1yf57n9sb

How to Choose Dividend Stocks - Morningstar

Dividend Growth Investing for Beginners

Dividend Growth Investing for Beginners

Written by Tyler

When you, as an investor, are looking at income earning opportunities, you should definitely mull over the option of dividend growth investing. Dividends allow you to enjoy your share in the profit of a company on a quarterly basis. Dividends are the total amount of money that a particular company pays out to its shareholders. The amount of dividend depends upon the performance of the company and dividend growth requires that a company have a sustainable growth model. Remember, however, that dividend payments are not set in stone. It entirely depends upon the prerogative of the company to offer dividends to its shareholders, or not.

Dividend growth investing is an excellent strategy that you can use to maximize your cash income generated from your equity investments. In fact, if you can put in place a smart and consistent dividend growth strategy, you can replace the income from your regular job. Or, if you are in debt, you can utilize the dividend proceeds to become debt free.

However, to design a successful dividend growth investing strategy, you must have good knowledge of the dividend growth companies on the market. To find dividend growth stocks, you can check out the historical dividend performance of various companies on the Dividend Achievers andDividend Aristocrats lists.

Of course, past good performance does not ensure robust future performance. Rather, you have to select stocks which are fundamentally strong and which are undervalued at the current time to frame out a successful dividend investing strategy. Here are few tips so that you can find out successful dividend investing strategy.

Dividends are not rights but privileges

It is to be kept in mind that dividends are not guaranteed, rather they are more like privileges enjoyed by the shareholders. It depends entirely upon the discretion of the board of directors of a company to issue dividends to the shareholders, given the condition that the company has scripted a solid financial performance. Paying dividends to the shareholders shows the financial strength of a company and it also attracts income-minded investors to the company’s fold. Again, when a company cuts back the dividend amount, it shows that the company is not doing well.

Be skeptical about very high dividend yields

Do not expect to earn huge money with super-yield dividends. In fact as a general rule, any dividend yield which is over two and a half times the broader market, should be viewed skeptically. It has been seen time and again that many stocks fared exceedingly well and fetched super returns and dividends to the shareholders during the bull phase but plummeted appreciably during the bear phase, offering no dividends at all to the shareholders. This has been the case with many real estate investment trust (REITs), with their stock prices receiving a serious drubbing during the bear phase.

Analyze the cash flow statement

To find a high-dividend stock, it is important to analyze the cash-flow statement of a company. Check whether the company has the required cash to pay out the dividends or it is resorting to debt or selling stock to finance the dividend payment. If the company is selling stocks or resorting to debt to pay out the dividends to the shareholders, it can’t be a sustainable.

Follow the above mentioned tips to find out successful dividend investing strategy and to earn a lot of money.

This guest post is written by I Davis. She is the Community Member ofhttp://www.creditmagic.org/ and has been contributing her suggestions to the Community. She is quite knowledgeable of various financial matters like tracking down identity theft, money investment tips, credit card debt, credit card fraud and has a unique approach to analyze them. Check out her articles on various financial topics with special emphasis on ‘Credit’ related issues.

http://dividendmoney.com/dividend-growth-investing-for-beginners/

Guinness Anchor Christmas cheer: Remember to Reinvest the Special Dividend

Investing is simple, but not easy.  Here is the rough calculation of the returns from Guinness for those who bought and held for the long term.

20.8.1992  Bought Guinness @ 4.38

13.12.2011  Guinness is trading @ 12.98

Investing period:  19 years

Capital gains:  8.60

Capital gains CAGR:  5.88%

Dividends paid in 1992:  36.4 sen  DY based on cost:  8.31%

Dividends paid in 2011:  54 sen  DY based on cost:  12.33%

Average DY over the last 19 years:  10.3%

Total average yearly return from Guinness = 5.88% (capital gain) + 10.3% (dividend) = 16.2%.

This is yet another stock that has returned 15% per year to its shareholders over many years consistently.

The total average return per year from Guinness = 16.2%.  
Let us translate this into CAG returns over the 19 year period.

Assuming the dividends were not reinvested into Guinness:
The total returns from this investment are as follow:
At end of 19 years, the 4.38 initial investment would have grown to 12.96.
The amount of dividend collected over the 19 years was 8.94.
Therefore, the initial 4.38 has become 12.96+8.94 = 21.90 over 19 years.
This gives a CAGR of 8.84%.

The DY of Guinness over many years range from 5.4% to 7.0% (average 6%).  

Assuming the dividends were reinvested at the end of each financial period back into Guinness and that theaverage DY was 6% for each investing year.
At the end of 19 years, the 4.38 initial investment would have grown to 41.60.
This gives a CAGR of 12.58%.

Assuming the dividends were reinvested at the end of each financial period back into Guinness and the DY for each period was the lowest of 4% for the 19 years.
At the end of 19 years, the 4.38 initial investment would have grown to 28.42.
This gives a CAGR of 10.34%.

.. and if you have bought GAB in Jun 2008 ...

Counter   Purchase Date   Price      Current Price       
GAB      04-Jun-08           5.35           13.14

Total % gain (excluding dividends)  145.6%.
This is a CAGR of 25.19% over 4 year period or 35% over 3 year period in its share price, excluding dividends.   


There are times when you can buy these great stocks cheap.  You will get fantastic returns over the initial few years of your "good timing pricing" in your investing.  Over the long period, the returns will attenuate to those of what the stock delivers over its long term.

(The above calculations of returns exclude special dividends.)

A surprisingly large part of the overall growth in most portfolios comes from reinvested dividends rather than in appreciation of the stock prices. A yield of 3% may appear small but over a period it makes a big difference. Choose some investments with a solid history of dividends and use them as the ballast in your ship.

--------------------

Wednesday December 14, 2011

Guinness Anchor Christmas cheer

Special dividend higher than last year’s full dividend

GUINNESS Anchor Bhd's (GAB) shareholders are getting some Christmas cheer when it came to light on Monday that the brewery will be disbursing a special single-tier dividend of 60 sen per 50 sen share for the financial year ending June 30, 2012 (FY12), which, notably, is even higher than its full-year FY11 dividend per share (DPS) of 54 sen.

If you were paying attention though, this would not have been a total surprise. StarBiz had previously reported in October that GAB's management was looking at ways to reward shareholders, a move not uncommon among cash-rich brewers.

A report by OSK Research analyst Jeremy Goh on Nov 29 had highlighted the possibility of a higher dividend, either through a higher payout ratio or special dividend. “In fact, we do not discount the possibility of a special dividend,” he said at the time, adding that GAB has a cash pile of RM164mil, or 54 sen per share.

In a follow-up report, Goh said that with the just-announced dividend, the DPS for FY12 would almost double from 61 sen to RM1.21, based on a 90% payout rate. This, he said, translated to a “very attractive yield” of 9.9%.

But in Malaysia's relatively small beer market where two players dominate GAB's latest move inevitably prompts the question: will its closest rival,Carlsberg Brewery Malaysia Bhd, soon do the same?

Carlsberg's shareholders might seem to think so. While both shares were on the top gainers list yesterday, with GAB adding 70 sen to RM12.98 and Carlsberg 31 sen to RM8.46, the latter's stock traded more than twice as heavily. As many as 469,700 Carlsberg shares changed hands versus GAB's 221,600 shares.

Analysts, however, are not counting on a bumper dividend from Carlsberg. As at Sept 30, it had RM82.7mil in cash and RM94.2mil in loans and borrowings as opposed to GAB, which had zero debt and RM164mil in cash and cash equivalents.

An analyst said that based on historical performance, Carlsberg's dividend payout averaged 50% to 70% against GAB, which paid out 90% of its earnings in FY11.

Nonetheless, Carlsberg did reward shareholders with a 58 sen dividend last year after it acquired Carlsberg Singapore Pte Ltd for RM370mil in the fourth quarter 2009.

Another analyst pointed out that while Carlsberg and GAB were fierce competitors, they had not been known to compete on the dividend front.

On the rationale for GAB's distribution of a special dividend, analysts said it was to optimise the brewery's capital structure. An analyst explained that GAB had to choose between making an acquisition or capital management, and since the choice of acquisition targets in Malaysia was limited, it opted to distribute cash to shareholders.

“Even when Carlsberg made an acquisition last time, it was in Singapore,” she noted.

GAB also recently proposed to issue RM500mil in debt notes for capital expenditure (capex) and working capital. Of the RM80mil-RM100mil capex to be spent in FY12, RM40mil has been apportioned to a new packaging line and RM30mil to upgrade its information technology infrastructure. The debt papers were given an AAA rating by RAM Ratings.

OSK's Goh, in his Nov 29 report, had also said that GAB was debt-free prior to the debt issuance, which raised its weighted average cost of capital (WACC) to 7.1%. The new debt notes, he said, would bring its WACC down to a more efficient 5.4%, assuming an effective tax rate of 25%, and the company's debt to equity ratio to 47:53.

On whether another extraordinary dividend was in the offing from GAB, its finance director Mahendran Kapuppial told StarBiz: “We do not have any plans for further special dividends.

“Historically, we have paid between 85% and 90% of our profit after tax as normal dividends to our shareholders and we do expect this to continue in the future. Looking at our current debt to equity ratio, the board felt that a one-off special cash dividend is appropriate.”

http://biz.thestar.com.my/news/story.asp?file=/2011/12/14/business/10091275&sec=business

----------------------------------

Why Buy and Hold Will Always Be a Sound Investing Strategy

It seems like the debate regarding the merits of the "buy-and-hold" investing strategy is alive and well. We always find these discussions amusing, because we believe that it is such a pointless discussion. There is no general argument or case that can be made to support the buy-and-hold strategy or to negate it.

The only true answer to the buy-and-hold argument is it depends on what and/or when you buy-and-hold.

• If you buy the right company at the right price, then buy-and-hold is a great strategy. 
• If you buy the wrong company at any price, then the buy-and-hold strategy is a dumb move. 
• Also, if you buy the right company at the wrong price, then buy-and-hold would once again be a bad move.

http://myinvestingnotes.blogspot.com/2010/10/why-buy-and-hold-will-always-be-sound.html

3 Reasons You Must Invest In Dividend Stocks (Dividend growth investing)

3 Reasons You Must Invest In Dividend Stocks

Written by Tyler 

As a dividend growth investor, I am frequently asked why I don’t invest in high growth stocks and, more importantly, why I believe investing for dividends is a more appropriate strategy.

In bear markets there are great buying opportunities for dividend growth stocks that are offering yields above their historical averages.  Opportunities to buy great dividend growth stocks at above average yields is a great way to finance your retirement and increase the compounding effect of your future income from these stocks.

Here are the 3 most essential reasons that I prefer dividend investing: 

1.) Dividends offer investors fantastic flexibility.

Dividends give you tremendous financial flexibility throughout your investing life. While you’ve got an income from working, you can reinvest those payments to speed the process of compounding your wealth. Once you’ve decided to retire, the cash thrown off by dividends spends just as well as any other source of money!

What is even better, a rising dividend payment can help you fight inflation by providing you more cash every single year.

2.) You can’t fake money in your pocket. 

Dividends also have the added bonus of being exceptionally difficult for companies to fake. After all, it’s difficult to convince lenders to loan money to a company if that company is going to turn around and hand it over to its shareholders.

As a result, to sustainably make and increase those dividends, the business needs to generate serious cash on both a regular and repeatable basis.

3.) Dividends are paid from the company’s cash flow. 

Perhaps most important, a company’s dividend payment comes from its operational success and not from the panic, hype, or analyst interpretations that influence its stock price. Throughout these rocky market periods, dividend payments allow us to make money even when the stock price moves lower.

Why Invest In Dividend Paying Stocks?

• Quicker compounding.
• Increased financial flexibility.
• Cash in your pocket without selling.
• A hedge against inflation.
• An check on the company’s accounting.
• Cash Flow in a down market.

With all of the benefits of dividends, it’s obvious why they can be an integral component of one’s portfolio.

Did I miss any benefits of dividends?  If so, let me know in the comments! 

http://dividendmoney.com/three-essential-reasons-to-invest-for-dividends/

Valuing A Stock With Supernormal Dividend Growth Rates

by Peter Cherewyk 

The supernormal growth model is most commonly seen in finance classes or more advanced investing certificate exams. It is based on discounting cash flows, and the purpose of the supernormal growth model is to value a stock which is expected to have higher than normal growth in dividend payments for some period in the future. After this supernormal growth the dividend is expected to go back to a normal with a constant growth. (For a background reading, check out Digging Into The Dividend Discount Model.)

Tutorial: Discounted Cash Flow Analysis

To understand the supernormal growth model we will go through three steps.

1. Dividend discount model (no growth in dividend payments)

2. Dividend growth model with constant growth (Gordon Growth Model)

3. Dividend discount model with supernormal growth

Dividend Discount Model (No Growth in Dividend Payments)
Preferred equity will usually pay the stockholder a fixed dividend, unlike common shares. If you take this payment and find the present value of the perpetuity you will find the implied value of the stock.

For example, if ABC Company is set to pay a $1.45 dividend next period and the required rate of return is 9%, then the expected value of the stock using this method would be 1.45/0.09 = $16.11. Every dividend payment in the future was discounted back to the present and added together.

V = D1/(1+k) + D2/(1+k)2 + D3/(1+k)3 + ... + Dn/(1+k)n

Where:
V = the value
D₁ = the dividend next period
k = the required rate of return

For example:

V = $1.45/(1.09) + $1.45/(1.09)2 + $1.45/(1.09)3 + … + $1.45/(1.09)n V= $1.33 + 1.22 + 1.12 + . . . V= $16.11

Because every dividend is the same we can reduce this equation down to: V= D/k

V=$1.45/0.09

V=$16.11

With common shares you will not have the predictability in the dividend distribution. To find the value of a common share, take the dividends you expect to receive during your holding period and discount it back to the present period. But there is one additional calculation: when you sell the common shares you will have a lump sum in the future which will have to be discounted back as well. We will use "P" to represent the future price of the shares when you sell them. Take this expected price (P) of the stock at the end of the holding period and discount it back at the discount rate. You can already see that there are more assumptions you need to make which increases the odds of miscalculating. (Explore arguments for and against company dividend policy, and learn how companies determine how much to pay out, read How And Why Do Companies Pay Dividends?)

For example, if you were thinking about holding a stock for three years and expected the price to be $35 after the third year,  the expected dividend is $1.45 per year.

V= D1/(1+k) + D2/(1+k)2  + D3/(1+k)3 + P/(1+k)3 V = $1.45/1.09 + $1.45/1.092 + $1.45/1.093 +$35/1.093

Dividend Growth Model with Constant Growth (Gordon Growth Model)
Next let's assume there is a constant growth in the dividend. This would be best suited for evaluating larger stable dividend paying stocks. Look to the history of consistent dividend payments and predict the growth rate given the economy the industry and the company's policy on retained earnings.

Again we base the value on the present value of future cash flows:

V = D1/(1+k) + D2/(1+k)2+…..+Dn/(1+k)n

But we add a growth rate to each of the dividends (D₁, D₂, D₃, etc.) In this example we will assume a 3% growth rate.

So D₁ would be $1.45(1.03) = $1.49

D₂ = $1.45(1.03)² = $1.54

D₃ = $1.45(1.03)³ = $1.58

This changes our original equation to : 

V = D1(1.03)/(1+k) + D2(1.03)2/(1+k)2+…..+Dn(1.03)n/(1+k)n V = $1.45(1.03)/(1.09) + $1.45(1.03)2/(1.09)2 + $1.45(1.03)3/(1.09)3 + … + $1.45(1.03)n/(1.09)n V = $1.37 +$1.29 + $1.22 + …. V = 24.89

This reduces down to: V = D₁/k-g

Dividend Discount Model with Supernormal Growth
Now that we know how to calculate the value of a stock with a constantly growing dividend we can move on to a supernormal growth dividend.

One way to think about the dividend payments is in two parts (A and B). Part A has a higher growth dividend; Part B has a constant growth dividend. (For more, see How Dividends Work For Investors.)

A) Higher Growth
This part is pretty straight forward - calculate each dividend amount at the higher growth rate and discount it back to the present period. This takes care of the supernormal growth period; all that is left is the value of the dividend payments which will grow at a continuous rate.

B) Regular Growth
Still working with the last period of higher growth, calculate the value of the remaining dividends using the V = D₁/(k-g) equation from the previous section. But D₁ in this case would be next year's dividend, expected to be growing at the constant rate. Now discount back to the present value through four periods. A common mistake is discounting back five periods instead of four. But we use the fourth period because the valuation of the perpetuity of dividends is based on the end of year dividend in period four, which takes into account dividends in year five and on.

The values of all discounted dividend payments are added up to get the net present value. For example if you have a stock which pays a $1.45 dividend which is expected to grow at 15% for three years then at a constant 6% into the future. The discount rate is 12%.

Steps

1. Find the four high growth dividends.

2. Find the value of the constant growth dividends from the fifth dividend onward.

3. Discount each value.

4. Add up the total amount.

Period	Dividend	Calculation	Amount	Present Value
1	D1	$1.45 x 1.151	$1.67	$1.50
2	D2	$1.45 x 1.152	$1.92	$1.56
3	D3	$1.45 x 1.153	$2.21	$1.61
4	D4	$1.45 x 1.154	$2.54	$1.67
5	D5 …	$2.536 x 1.06	$2.69
		$2.688 / (0.11 - 0.06)	$53.76
		$53.76 / 1.114		$35.42
			NPV	$41.76

Implementation
When doing a discount calculation you are usually attempting to estimate the value of the future payments. Then you can compare this calculated intrinsic value to the market price to see if the stock is over or undervalued compared to your calculations. In theory this technique would be used on growth companies expecting higher than normal growth, but the assumptions and expectations are hard to predict. Companies could not maintain a high growth rate over long periods of time. In a competitive market new entrants and alternatives will compete for the same returns thus bringing return on equity (ROE) down.

The Bottom LineCalculations using the supernormal growth model are difficult because of the assumptions involved such as the required rate or return, growth or length of higher returns. If this is off, it could drastically change the value of the shares. In most cases, such as tests or homework, these numbers will be given, but in the real world we are left to calculate and estimate each of the metrics and evaluate the current asking price for shares. Supernormal growth is based on a simple idea but can even give veteran investors trouble. (For more, check out Taking Stock Of Discounted Cash Flow.)

by Peter Cherewyk (Contact Author | Biography)

Peter Cherewyk has worked in the financial field for over 10 years. He completed his Bachelor of Commerce from the University of Alberta, and is currently working towards a Chartered Financial Analyst designation. He enjoys hockey and hiking and the opportunity to teach others.

Filed Under: Dividend, Fundamental Analysis, Stock Analysis, Stocks

http://www.investopedia.com/articles/fundamental-analysis/11/supernormal-growth-analysis.asp

Australia's 10 best businesses

Greg Hoffman

October 5, 2010 - 2:59PM

Computershare is one of the five businesses to make it onto The Intelligent Investor's 10 Best Businesses list two years running. It's produced impressive figures; 40 per cent annual dividend growth over the past decade, a return on capital in the mid-teens and a return on incremental capital (the additional capital that's been put in over the past decade) of more than 20 per cent.

So why has the company's share price lagged the All Ordinaries index over the past 10 years?
In a word, ``expectations''. A decade ago, after a staggering 36-fold increase over the prior five years, investors were paying a price-to-earnings ratio (PER) of more than 100 for Computershare.

A PER much above 20 requires decent profit growth in order to justify it; at over 100 it had become extremely stretched. That fact that investors who paid those tech boom prices have been able to achieve positive returns at all is remarkable enough.

Finest businesses

In what's now an annual, post-reporting season ritual, our team has recently crunched the numbers and arrived at a list of the finest businesses listed on the Australian sharemarket.

It's a subjective exercise, of course, but the process we think is quite robust. Starting with all of the stocks in the ASX 200 index, we passed them through analytical filters such as

• 5- and 10-year dividend growth, 
• 10-year average return on capital employed and 
• return on incremental capital employed.

Share price performance is not one of the measures: if a business performs well on the measures we've selected, its share price is bound to take care of itself.

Computershare is perhaps the exception that proves this rule. It's the only one of the 10 businesses to make our final list whose total shareholder returns have failed to beat the market over the past decade. As renowned investor Ben Graham put it, in the short run the market is a voting machine, in the long run it's a weighing machine.

Competitive advantage

In analysing the final list of Australia's 10 Best Businesses, a number of themes emerged. The most important is that the key to great long-term investment returns is some form of sustainable competitive advantage.

This might be in the form of a strong brand like David Jones, a powerful distribution network of the likes of Woolworths and Metcash, or patented technology from a company like Cochlear. Yes, all these stocks made it onto the list of Australia's 10 best businesses.

Sometimes a competitive advantage can be built by reliably delivering results to clients over a long period, as is the case with Leighton and Monadelphous. But this is potentially a weaker type of advantage and one that could be lost more readily than other kinds.

Also, over a short period (say one to three years), it's difficult to distinguish between profits that are the result of a strong competitive advantage and profits that are the result of a powerful industry upswing.
Another point to consider is that a strong competitive advantage often doesn't last. Recently, shareholders of Tattersalls and Tabcorp have learned this the hard way. Exclusive government licences provide a strong advantage but they have a finite life and most of the `excess value' they generate will probably be competed away in the new licence bidding process.

Each year we find it useful to survey the investing landscape from this long-term, numbers-driven perspective. And, if you're keen to work through such calculations yourself, I'm currently recording a `how to' online video series, using Telstra as a case study. The first two videos are available now, and I'll be posting the others later in the week.

This article contains general investment advice only (under AFSL 282288).

Greg Hoffman is research director of The Intelligent Investor. BusinessDay

 http://www.brisbanetimes.com.au/business/australias-10-best-businesses-20101005-165i0.html