Chin Kian Wee asked 3 years ago
what would it indicate if growth is greater than the required return k < g?
On the other hand, I noticed that US stocks do not have “dividend payout ratio” , thus I couldn’t calculate g =roe*(1-dividend payout ratio). Do you have any stock analysis video for US stocks for learning?
KCLau Staff answered 3 years ago
1. Can g > k?
When g is high, and higher than k, if that is for sure – then there seems like investor would pay anything for the stocks. Imagine a company that keeps growing every year for 20%, for 100 years! It will be worth too much.
But in reality, the g in the formula is referring to perpetual growth (forever). Which we know that couldn’t be the case because there is a finite growth – population has a limit. In short, no matter how fast the company grow, it couldn’t be more than the ROE if they retain all profits and don’t pay dividend. And in the perpetual term, g < ROE (without any additional capital injection)
So in the real world, we put a LIMIT CAP on the g. I always cap it at 10% limit even the g for the past 10 years is more than that.
2. Dividend payout for US stocks.
US companies pay out dividend too, although not all of them pay dividends (it will be taxed in the hands of shareholders who receive).
How to find it? It is in the Cash Flow statement in the Annual Report.
To get past five years dividend payout, you can find it at Morningstar. Look at Cash Flow Statement, under Cash Flow from Financing activities, “Common Stock Dividends”
For example Apple: https://www.morningstar.com/stocks/xnas/aapl/financials
Apple paid $14.05 billion dividend in 2019. And the profit in 2019 is $55.26 billion.
Dividend payout ratio = dividend / net profit = 14.05/55.26 = 25%
Chin Kian Wee
replied 3 years ago Thank you KC, I have a better understanding now
Chin Kian Wee answered 3 years ago
What if a certain US company does not pay dividend, for example TWITTER: https://www.morningstar.com/stocks/xnys/twtr/financials
In that case, how do you calculate the growth,g in order for Valuation later on ?
KCLauWe talked about three different methods to calculate growth. The other two don’t involve dividend. Check it out here: https://bursamethod.com/estimating-growth-rate/
Chin Kian Wee answered 3 years ago
This question may sound silly, what is the element that plays important role in V/B = (ROE-g) / (k-g) in determining the intrinsic value of a company share ?
In your SCC valuation, the intrinsic value is Rm 0.22 while the current price is Rm 0.52 . Does that mean we can’t buy this share unless it drops to Rm 0.22 ? In that case, it might take us some time to wait for buying it.
Estimated Value for SCC = RM 43.36 mil
Estimated value with 30% margin of safety = 0.7 x RM 43.36 mil = RM 30.42 mil
Current market cap of SCC = RM 72.7 mil
We can convert the market cap and value to price
Number of shares outstanding = 138.8 mil shares
Current price = RM 0.52
Estimated entry price with 30% margin of safety = RM 0.22
The formula is not a hard rule. It provides a way to estimate the intrinsic value.
However, business is dynamic. There are so many factors to affect a business performance.
Among the variables ROE, g and k, in my opinion, the most important is the ROE. Without a good ROE, the company wouldn’t produce enough cash to grow and reward the shareholders.
For SCC example, the number just give us a guide that the current price is not attractive enough according to our standard. If you lower your expection (k), the price you are willing to pay will be higher (RM0.22).
The good news is, there are thousands of stocks out there. And there are over hundreds of good businesses that are traded publicly. As a smart investor, we simply allocate the fund to the good businesses that make sense to us that we are more certain that they will stay good for a long term.
Don’t be entice to invest .. just keep looking and analysing more companies. You will soon find companies that you are comfortable to buy, at a sensible price.