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An alternative to the Dividend Growth Model (DGM) to estimate the market price of common stock...

Question

An alternative to the Dividend Growth Model (DGM) to estimate the market price of common stock...

An alternative to the Dividend Growth Model (DGM) to estimate the market price of common stock in companies which do not pay dividends is use of a market multiple such as Price to Earnings or Price to Sales.

Answers

There are multiple alternatives to DGM as categorized below:

Intrinsic Method Alternatives:

Ideally DGM is an intrinsic method of valuation and hence if we are looking at an alternative in intrinsic method, then it needs to be somthing like DCF- Discounted Cash Flow

DCF has many types like FCFF (Free Cash Flow to Firm) , FCFE (Free Cash Flow to Equity), CCF (Capital Cash Flow)

Further there are other intrinsic models like APV (Adjusted present Value) method of valuation

Market Multiple Method:

If we are looking for Market Multiple Methods which are also called relative valuation method then we can use amny parameters like EV/ EBITDA, P/E etc

Specifically in terms of using Price to Earnings or Price to Sales:

Technically, Price to Earnings is the the correct metric to use and Price to Sales is the wrong metric (while it is used by some market analysts). Let me explain why Price to Earnings is correct while Price to Sales is wrong:

Price is for Equity shareholders and Earnings taken is also for Equity Share holders and hence Price to Earnings ratio is proper apple to apple comparison, while in Price to Sales, Price is for Equity Shareholders but Sales (generated from total assets is funded by both equity and debt) is for both equity and debt share holders and hence it becomes an apple to oranges comparison. Hence Price to Earnings is the proper technical comparison.

In cases where the compared companies do not have debt, we can say that Price to Sales can be used, else this is not a proper comparison metrics.


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