## Monday, December 08, 2014

### DDM valuation for Blue-black Blue chips

Let's do some low ball valuation for a few blue chips, most of them beaten until blue-black.

I'm using a dividend discounted (DDM) model, with the assumptions:

1. Zero growth rate for dividend
2. Rate of return required = 5% (twice as much as CPF's OA account)
3. Dividends given till perpetuity
4. No special dividends included, unless they occur every year. I'll guesstimate in that case.
5. I'm using a geometric progression, specifically the sum to infinity with first term as the dividend at year 0 and the geometric ratio as the ratio between the 1st yr and the 0th year. The formula is:

Sum to infinity = First term / (1 - geometric ratio)

Here's an example of a company, ACME, that pays 100 cts dividends every year.

The sum is 100/(1-(95.238/100)) = \$21.

Alright? Let's go:

1. ST Engineering

Dividends per share: 14 cts
Sum = \$2.94
Price now = \$3.36

2. OCBC

Dividends per share: 34 cts
Sum = \$7.14
Price now = \$10.33

3. DBS

Dividends per share: 54 cts
Sum = \$11.34
Price now = \$19.73

4. Kepcorp

Dividends per share: 40 cts
Sum = \$8.4
Price now = \$8.21

5. Sembcorp Marine

Dividends per share: 12 cts
Sum = \$2.52
Price now = \$2.92

6. SIA Engineering

Dividends per share: 20 cts
Sum = \$4.20
Price now = \$3.95

7. Sembcorp Industries

Dividends per share: 15 cts
Sum = \$3.15
Price now = \$4.16

Take away:

I highlighted the 2 companies where the current price now is lower than this low ball method of calculating the intrinsic value of the company. If you look at Kepcorp, this method gives a value of \$8.4. This means that if you take it that Kepcorp is going to give you dividends forever at 40 cts per year, not a cent more or less, AND if you want a return of 5%, you should get it at \$8.21. Any dividends above 40 cts is a bonus (because it's not included in the calculations) for you, so is any special dividend declared if any. So how sure are you of getting the 40 cts dividends? That's the ultimate question.

#### 13 comments :

SMK said...

Kudos on using something a secondary school student can understand. :)

I guess most readers will miss out on the importance of the last 2 sentences. Anonymous said...

Hi,

1. For DDM, the formula is always D1/(r-g). For your ACME example, Sum = 0.1/(0.05-0) = \$2. If you plus D0 = \$1, you get the same \$21. This formula is easier to calculate than your example..

2. IMHO, we should expect more than a 5% returns in investing the stocks that you mentioned.

M

la papillion said...

Hi SMK,

Thanks :) That's how I understand of the DDM, haha

Then I should highlight them here again:

"So how sure are you of getting the 40 cts dividend? That's the ultimate question."

la papillion said...

Hi M,

I saw the formula, but I don't really understand it, hence I used my own. At first, I also don't understand why using the standard formula gives \$20 and not my calculated \$21. But thanks to your pointers, I think I do now. As you've rightly pointed out, I calculated my first term as the 0th yr, but the standard one didn't. Thanks a lot for that :)

And you're right. It's easier using the formula than my own, but as I've mentioned, I've problems understanding it (most sites don't derive it), so I'm hesitant to use it.

I think a starting point is 5%. I use it for planning purpose actually. For any investment I put in, minimally I want to get is 5% (dividends + capital), hence that discount rate. We can aim higher..8%? 10%? But 5% level is what I'll be looking at. If the price falls cheaper than that, I know I'll be hitting at least my min. LVP said...

I come in to seek opinion on today's share price of Sembcorp Marine. Like dropped substantially... what do you all think?

Good time to enter liao bo? hee :D

Halcyon Tomorrow said...

IMO, your DDM for SIAEC makes the current price look good. However given the recent slowdown in the regional aviation MRO sector, I'm reckoning SIAEC might not be able to pay out 20 cents of dividend this year. I am guessing it will range between 16-18 cents, depending on their next 2 quarters.

Disclosure: I'm long SIAEC

la papillion said...

Hi LVP,

la papillion said...

Hi Halcyon,

Well, I'm not too interested in the aviation industry...maybe you do because you're in it ;) You shld know something I don't haha

Thanks for commenting, I don't believe I've seen you here

K said...

Hi,

Does anyone know if there is any "program" or "stockbroker" that tracks your stocks P/L inclusive of dividends automatically? I am using iOCBC and it just tracks your market price and buy price to give you are P/L% excluding dividends.

Thanks.
K

la papillion said...

Hi K,

I don't think so. You can just do it on an excel yourself? It's not that hard to track it and it allows more flexibility than any software out there, if there's any. You can check out Investment moats...he did a dividend tracker, and maybe he might have such a spreadsheet template already out.

secretinvestors said...

Hi,
Nice post there regarding the DDM model :)

I guess a quick way to look at this based on the 'standard' zero-growth DDM formula is probably just the dividend yield. If the rate of return required is 5%, then any dividend yield above 5% is what we want. DDM zero-growth model: Sum = D/r. Rearranging them becomes D/Sum = r. Substitute Sum with Market price and if we want a return greater than required return, it becomes D/P > r --> Dividend yield > r.

Your conclusion about how sustainable is the dividend and whether there will be special dividends or dividends cut is very true. Great post there. Will follow your post from now :)

la papillion said...

Hi secretinvestors,

Haha, actually I knew about that formula, it's just that I don't know how they derived it so I didn't use it. What I did is actually the same thing as that formula, it's just that I used the 0th dividend instead of the 1st.

But having worked out the formula, if u take dividend/price to get the yield, I now know that the yield calculated has certain assumptions that nobody talks about. It is based on a zero growth dividend model, paying the same dividend (as used in the calculation) until infinity.

If ever the dividend changes, esp if it decreases, or if it doesn't give dividend till infinity, the valuation will fail. That's the most Impt takeaway for me :)

secretinvestors said...

Hi la papillion,

You're right about that. Typically investors use the current dividend yield as a gauge. Probably its also good to check the track record of dividend payouts of the company itself. But I guess its still not a foolproof way of ensuring dividends can be sustained. Do visit my blog when you're free and give your feedbacks too.

Thanks for the insight :)