Financial Management: Core Concepts, Third Edition

7.4 Dividend Model Shortcomings

The dividend models (constant growth and constant dividend) appeal to the fundamental concepts of asset pricing: (1) the future cash flow to which the owner is entitled while holding the asset and (2) the required rate of return for the cash flow determine the value of a financial asset. A problem arises, however, in that future cash flow may be difficult to predict as to timing and amount. To illustrate this failure, let’s look first at five different companies in which the dividend growth model appears to work well with their recent dividend histories. We will then look at five other companies in which the model does not provide us with a reasonable estimate and is out of line with our understanding of a reasonable ...