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Forecasting future dividend distributions to see if there is any catalyst for a price change.

Why Las Vegas Sands Corp’s (NYSE: LVS) Dividend Yield Looks Unattractive

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Las Vegas Sands Corp (NYSE: LVS) currently pays a dividend yield of 3.8% which is above the Consumer Discretionary sector median of 2.1%. While this makes the total return potential for Las Vegas Sands Corp look attractive, investors may change their mind when analyzing the company’s future dividends. In this article, I calculate Las Vegas Sands Corp’s fair value by forecasting its dividend distributions and discounting them back to today’s value.


Valuation Methodologies Are Not Made Equally

The Dividend Discount Model (DDM) estimates the value of a company’s stock price based on the theory that its worth is equal to the sum of the present value of its future dividend payments to shareholders.

But how do we know if it’s appropriate to use a dividend discount analysis when estimating the fair value of Las Vegas Sands Corp? Many analysts find it difficult when trying to figure out the correct valuation methodology for a given company or are biased towards one specific approach. This is often a mistake which can negatively impact investment decisions and result in trading losses or missed opportunities. No two companies are the same and every business consists of unique characteristics that may require you to adjust your analysis.

Understanding leverage trends is the first step when determining what valuation analyses are relevant for a given company. When a company’s leverage doesn’t fluctuate or is expected to remain stable over time, then an equity valuation model (e.g. equity DCF, DDM) will be the most appropriate valuation technique. The reason for this is because when leverage is stable, interest expense on debt can typically be projected with much more reliability.

How do we check if a company’s leverage has been fluctuating or is expected to do so? This isn’t always straightforward but checking recent debt ratio trends can be a good indicator. Las Vegas Sands Corp’s debt to equity ratio has been relatively stable over last few years ranging from 111.0% to 128.0%. This suggests that an equity valuation model is a suitable technique when valuing the company’s shares. Now does it make sense to use a dividend discount model knowing that an equity valuation technique is an appropriate methodology?

The next step is to figure out if Las Vegas Sands Corp pays a dividend and if so, is its payout ratio relatively high (typically above 70%)? The table below highlights this information.

Las Vegas Sands Corp Payout Ratio Table

Source: Las Vegas Sands Corp dividend discount model

Las Vegas Sands Corp distributed a total of $2,943 million in cash dividends to shareholders in its most recent fiscal year Dec-17 which represented a payout ratio of 104.9%. It appears that the company meets both criteria. Therefore, it is fitting to use a dividend discount model when determining the fair value of Las Vegas Sands Corp stock.


Forecasting Las Vegas Sands Corp’s Dividends

The first step in building a dividend discount model is to forecast net income since forecasting dividends directly can be difficult. So let’s create a net income forecast for the next five years and use that as the basis for projecting future dividends.

As of May 13, Wall Street analysts are projecting a mediocre growth rate in the company’s bottom-line over the next five years. Net income is expected to reach $3,611 million by fiscal year 2022.

Las Vegas Sands Corp Net Income Growth Chart

Source: Las Vegas Sands Corp Projected Net Income Growth

I use the net income projections above to serve as the basis for my dividend forecast. The next step is to forecast the payout ratio where I selected 90.0% for the next fiscal year which is in line with historical levels.

Las Vegas Sands Corp Dividend Forecast

Source: Las Vegas Sands Corp dividend discount model


Calculating Las Vegas Sands Corp’s Fair Value

The last step is to select a discount rate to calculate the present value of the forecasted dividends. I used finbox.io’s Weighted Average Cost of Capital (WACC) model to help arrive at an estimate for the company’s cost of equity.

I determined a reasonable discount rate for Las Vegas Sands Corp to be 10.0% at the midpoint. An updated cost of capital analysis using real-time data can be found at finbox.io’s Las Vegas Sands Corp WACC model page.

Las Vegas Sands Corp Dividend Fair Value Conclusion

The assumptions used in the dividend discount model calculate a fair value per share for Las Vegas Sands Corp of $54.37, -30.4% below its current stock price of $78.14. Therefore, LVS appears to be an overvalued stock and not necessarily a good entry point opportunity.


Conclusion: Dividends Don’t Support Stock Price

Discovering the fair value of a company can sometimes be difficult. However, determining an appropriate valuation methodology should not be. Knowing when and when not to use the dividend discount model will help in your investment decision making process.

However, it’s important to understand that a dividend discount model will inherently undervalue a stock. This is typically the result of the payout ratio assumption being less than 100% implying some cash leakage. Meaning the approach does not capture value that would otherwise build up as cash on the balance sheet. In practice, this excess retained cash is usually paid out to shareholders as special dividends or to make up for cash shortfalls for future dividends during economic downturns.

This helps explain, at least partially, why Las Vegas Sands Corp looks like an overvalued stock based on this approach. Nevertheless, a dividend discount analysis is still a helpful tool in combination with the understanding that it calculates a conservative intrinsic value estimate. Meaning an extremely attractive opportunity would be a stock where (1) a dividend discount model is appropriate and (2) shares looks undervalued based on its future dividends.

Note that there are a number of fundamental factors I have not considered in this analysis. I recommend that you continue your research on Las Vegas Sands Corp to gain a better understanding of its future prospects.

As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.

Why Blue Hills Bancorp Inc’s (NASDAQ: BHBK) Dividend Yield Looks Unattractive

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Blue Hills Bancorp Inc (NASDAQ: BHBK) has distributed 87.2% of its profits in the form of dividends over the last twelve months making the stock a prime candidate to be valued using a dividend discount analysis. Operating as a financial firm paying a dividend yield of 2.9%, could the small-cap stock be trading at an attractive valuation? Let’s take a look at the future dividend potential of Blue Hills Bancorp to see if there is any catalyst for a price change.


Application Of The Dividend Discount Model

The Dividend Discount Model (DDM) is a dividend-based valuation model that estimates the present value of a stock based on assumptions about its future dividend performance.

But before discussing the assumptions used in my dividend discount model for Blue Hills Bancorp, it’s first helpful to determine if this is actually an appropriate technique to be used when estimating its fair value. Many analysts find it difficult when trying to figure out the correct valuation methodology for a given company or are biased towards one specific approach. This is often a mistake which can negatively impact investment decisions and result in trading losses or missed opportunities. No two companies are the same and every business consists of unique characteristics that may require you to adjust your analysis.

Understanding leverage trends is the first step when determining what valuation analyses are relevant for a given company. When a company’s leverage doesn’t fluctuate or is expected to remain stable over time, then an equity valuation model (e.g. equity DCF, DDM) will be the most appropriate valuation technique. The reason for this is because when leverage is stable, interest expense on debt can typically be projected with much more reliability.

How do we check if a company’s leverage has been fluctuating or is expected to do so? This isn’t always straightforward but checking recent debt ratio trends can be a good indicator. Blue Hills Bancorp’s debt to equity ratio has been relatively consistent over last few years with a range spanning only 13.7%. This suggests that an equity valuation model is a suitable technique when valuing the company’s shares. Now does it make sense to use a dividend discount model knowing that an equity valuation technique is an appropriate methodology?

The next step is to determine if Blue Hills Bancorp pays a dividend and if so, is its payout ratio relatively high (typically above 70%)? The table below provides this information in more detail.

Blue Hills Bancorp Payout Ratio Table

Source: Blue Hills Bancorp dividend discount model

Blue Hills Bancorp distributed a total of $14 million in cash dividends to shareholders in its most recent fiscal year Dec-17 which represented a payout ratio of 87.2%. It appears that the company meets both criteria. Therefore, it is fitting to apply a dividend discount model when calculating the intrinsic value of Blue Hills Bancorp.


Projecting The Future Dividends Of Blue Hills Bancorp

The first step in building a dividend discount model is to forecast net income since forecasting dividends directly can be difficult. So let’s create a net income forecast for the next five years and use that as the basis for projecting future dividends.

Finbox.io applies consensus Wall Street estimates for the net income forecast when available. For the next fiscal year 2018, profits are expected to increase 27.8%, then grow 23.6% in 2019 and rise 12.5% in 2020.

Blue Hills Bancorp Net Income Growth Chart

Source: Blue Hills Bancorp Projected Net Income Growth

I use the projections above to serve as the basis for my dividend projections. The next step is to forecast the company’s payout ratio. In my estimates shown in the table below, I select a 14.0% payout ratio in 2018 and hold it steady there throughout the remainder of my projection period.

Blue Hills Bancorp Dividend Forecast

Source: Blue Hills Bancorp dividend discount model


Calculating Blue Hills Bancorp’s Intrinsic Value

Finally, we can now calculate Blue Hills Bancorp’s intrinsic value by present valuing its forecasted dividends. Note that we apply the company’s cost of equity to discount the future dividends since these payments are made to common shareholders or equity owners. I used finbox.io’s Weighted Average Cost of Capital (WACC) model to help arrive at an estimate for the company’s cost of equity.

I determined a reasonable cost of equity for Blue Hills Bancorp to be 9.7% at the midpoint. An updated cost of capital analysis using real-time data can be found at finbox.io’s Blue Hills Bancorp WACC model page.

Blue Hills Bancorp Dividend Fair Value Conclusion

My dividend forecast and cost of capital assumptions imply a fair value per share for Blue Hills Bancorp of $13.01, -36.9% below its current stock price of $20.60. Therefore, BHBK appears to be an overvalued stock and not necessarily a good entry point opportunity.


Conclusion: Dividends Don’t Support Stock Price

Finding the true value of a company can sometimes be difficult but determining an appropriate valuation methodology should not be. Knowing when and when not to use the dividend discount model will help in your investment decision making process.

But it is important to note that a dividend discount model will inherently undervalue a company’s stock. This is typically the result of the payout ratio assumption being less than 100% implying some cash leakage. In reality, this excess retained cash is usually paid out to shareholders as special dividends or to make up for cash shortfalls for future dividends during economic downturns.

This helps explain, at least partially, why Blue Hills Bancorp looks like an overvalued stock based on this approach. Nevertheless, a dividend discount analysis is still a helpful tool in combination with the understanding that it calculates a conservative intrinsic value estimate. Meaning an extremely attractive opportunity would be a stock where (1) a dividend discount model is appropriate and (2) shares looks undervalued based on its future dividends.

While a dividend discount analysis on its own is not necessarily indicative of a stock’s intrinsic value, it does provide helpful insights. I recommend that investors continue their research on Blue Hills Bancorp to gain a better understanding of all the factors driving its share price.

As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.

Why You Should Be Excited About Main Street Capital Corp’s (NYSE: MAIN) Dividends

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Main Street Capital Corp (NYSE: MAIN) is currently paying investors an above-average dividend yield of 5.9% while the Financials sector median stands at 2.2%. Even though this makes Main Street Capital look attractive relative to its peers, it’s useful to understand the company’s future dividend potential. Will Main Street Capital’s bottom line be the main catalyst driving future growth or maybe its payout ratio? Understanding these components and how they impact value may change your mind on the company’s future prospects.


Is A Dividend Analysis Appropriate?

Dividend Discount Model (DDM) is a way of valuing a company based on the theory that a stock is worth the discounted sum of all of its future dividend payments.

However, before walking through my dividend analysis for Main Street Capital, it’s first helpful to determine if this is actually an appropriate technique to be used when estimating its fair value. Many analysts are often biased towards one specific valuation approach which is typically a mistake that can negatively impact investment decisions and result in trading losses or missed opportunities. Every company has unique characteristics that may require you to adjust your analysis.

Understanding leverage trends is the first step when determining what valuation analyses are relevant for a given company. When a company’s leverage doesn’t fluctuate or is expected to remain stable over time, then an equity valuation model (e.g. equity DCF, DDM) will be the most appropriate valuation technique. The reason for this is because when leverage is stable, interest expense on debt can typically be projected with much more reliability.

How do we check if a company’s leverage has been fluctuating or is expected to do so? This isn’t always straightforward but checking recent debt ratio trends can be a good indicator. Main Street Capital’s debt to equity ratio has stayed relatively stable over last few years hitting a low of 57.8% in December 2017 and a high of 72.9% in December 2015. This suggests that an equity valuation model is a suitable technique when valuing the company’s shares. Now does it make sense to use a dividend discount model knowing that an equity valuation technique is an appropriate methodology?

We now must determine if Main Street Capital pays a dividend and if so, is its payout ratio relatively high (typically above 70%)? This helps figure out if the company distributes the majority of its profits to shareholders in the form of dividends.

Main Street Capital Payout Ratio Table

Source: Main Street Capital dividend discount model

Main Street Capital paid out a total of $148 million in cash dividends to shareholders in its most recent fiscal year Dec-17 representing a payout ratio of 87.0%. Therefore, it is fitting to use a dividend discount model when calculating the intrinsic value of Main Street Capital stock.


How To Project Main Street Capital’s Dividends

Since forecasting dividends directly can be difficult, the first step in building a dividend discount model is to project net income. So let’s create a net income forecast for the next five years and use that as the basis for our future dividends.

Applying consensus estimates, Wall Street is projecting an uninspiring growth rate in the company’s bottom-line over the next five years. Net income is expected to grow at an average annual rate of 2% bringing net income to $193 million by fiscal year 2022.

Main Street Capital Net Income Growth Chart

Source: Main Street Capital Projected Net Income Growth

I apply the net profit estimates above to drive my dividend forecast. The next step is to project the company’s payout ratio. In my estimates shown in the table below, I select a 88.0% payout ratio in 2018 and increase it to 90.0% by 2022.

Main Street Capital Dividend Forecast

Source: Main Street Capital dividend discount model


Discounting Main Street Capital’s Future Dividends

The final step is to present value the forecasted dividend distributions using a discount rate. I used finbox.io’s Weighted Average Cost of Capital (WACC) model to help arrive at an estimate for the company’s cost of equity.

I concluded a reasonable cost of equity for the company to be 9.5% at the midpoint. Although I don’t walk you through the CAPM assumptions that got me there, you can view the calculations using real-time data at finbox.io’s Main Street Capital WACC model page.

Main Street Capital Dividend Fair Value Conclusion

In conclusion, my dividend discount model calculates a fair value per share for Main Street Capital of $45.01, 16.7% above its current stock price of $38.65. MAIN appears to be an undervalued stock based on the company’s future dividend potential alone. Therefore, now may be a good time to purchase shares or increase your position in the company.


What This Means For Investors

An important component of the dividend discount model that investors should understand is that the technique will inherently undervalue a stock. This is typically the result of the payout ratio assumption being less than 100% implying some cash leakage. Meaning the approach does not capture value that would otherwise build up as cash on the balance sheet. In practice, this excess retained cash is usually paid out to shareholders as special dividends or to make up for cash shortfalls for future dividends during economic downturns.

Understanding that this approach calculates a conservative intrinsic value estimate is a very promising sign for investors searching for an entry point to buy the stock. Shares of Main Street Capital currently appear to be undervalued based on its future dividend potential alone. This means that MAIN may have significantly more upside than what I’ve calculated above.

Although a dividend discount model on its own is not necessarily indicative of a stock’s fair value, it does offer a number of useful insights. This valuation should only be the start of your analysis in relation to your total research. I recommend that you continue your review of Main Street Capital to gain a better understanding of its underlying fundamentals.

As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.

Discounting Quaker Chemical Corp’s (NYSE: KWR) Future Dividends To Estimate Fair Value

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Quaker Chemical Corp (NYSE: KWR) currently pays a dividend yield of 1.0% which is below the Materials sector median of 1.9%. While this makes the total return potential for Quaker Chemical look uninviting, investors may change their mind when analyzing the company’s future dividends. In this article, I calculate Quaker Chemical’s fair value by forecasting its dividend distributions and discounting them back to today’s value.


Valuation Methodologies Are Not Made Equally

The Dividend Discount Model (DDM) estimates the value of a company’s stock price based on the theory that its worth is equal to the sum of the present value of its future dividend payments to shareholders.

But how do we know if it’s appropriate to use a dividend discount analysis when estimating the fair value of Quaker Chemical? Many analysts find it difficult when trying to figure out the correct valuation methodology for a given company or are biased towards one specific approach. This is often a mistake which can negatively impact investment decisions and result in trading losses or missed opportunities. No two companies are the same and every business consists of unique characteristics that may require you to adjust your analysis.

Understanding leverage trends is the first step when determining what valuation analyses are relevant for a given company. When a company’s leverage doesn’t fluctuate or is expected to remain stable over time, then an equity valuation model (e.g. equity DCF, DDM) will be the most appropriate valuation technique. The reason for this is because when leverage is stable, interest expense on debt can typically be projected with much more reliability.

How do we check if a company’s leverage has been fluctuating or is expected to do so? This isn’t always straightforward but checking recent debt ratio trends can be a good indicator. Quaker Chemical’s debt to equity ratio has been relatively stable over last few years ranging from 16.1% to 21.5%. This suggests that an equity valuation model is a suitable technique when valuing the company’s shares. Now does it make sense to use a dividend discount model knowing that an equity valuation technique is an appropriate methodology?

The next step is to figure out if Quaker Chemical pays a dividend and if so, is its payout ratio relatively high (typically above 70%)? The table below highlights this information.

Quaker Chemical Payout Ratio Table

Source: Quaker Chemical dividend discount model

Quaker Chemical distributed a total of $19 million in cash dividends to shareholders in its most recent fiscal year Dec-17 which represented a payout ratio of 92.4%. It appears that the company meets both criteria. Therefore, it is fitting to use a dividend discount model when determining the fair value of Quaker Chemical stock.


Forecasting Quaker Chemical’s Dividends

The first step in building a dividend discount model is to forecast net income since forecasting dividends directly can be difficult. So let’s create a net income forecast for the next five years and use that as the basis for projecting future dividends.

As of May 7, Wall Street analysts are projecting a huge growth rate in the company’s bottom-line over the next five years. Net income is expected to reach $140 million by fiscal year 2022.

Quaker Chemical Net Income Growth Chart

Source: Quaker Chemical Projected Net Income Growth

I use the net income projections above to serve as the basis for my dividend forecast. The next step is to forecast the payout ratio where I selected 29.0% for the next fiscal year which is in line with historical levels.

Quaker Chemical Dividend Forecast

Source: Quaker Chemical dividend discount model


Calculating Quaker Chemical’s Fair Value

The last step is to select a discount rate to calculate the present value of the forecasted dividends. I used finbox.io’s Weighted Average Cost of Capital (WACC) model to help arrive at an estimate for the company’s cost of equity.

I determined a reasonable discount rate for Quaker Chemical to be 11.4% at the midpoint. An updated cost of capital analysis using real-time data can be found at finbox.io’s Quaker Chemical WACC model page.

Quaker Chemical Dividend Fair Value Conclusion

The assumptions used in the dividend discount model calculate a fair value per share for Quaker Chemical of $87.43, -40.4% below its current stock price of $146.49. Therefore, KWR appears to be an overvalued stock and not necessarily a good entry point opportunity.


Conclusion: Dividends Don’t Support Stock Price

Discovering the fair value of a company can sometimes be difficult. However, determining an appropriate valuation methodology should not be. Knowing when and when not to use the dividend discount model will help in your investment decision making process.

However, it’s important to understand that a dividend discount model will inherently undervalue a stock. This is typically the result of the payout ratio assumption being less than 100% implying some cash leakage. Meaning the approach does not capture value that would otherwise build up as cash on the balance sheet. In practice, this excess retained cash is usually paid out to shareholders as special dividends or to make up for cash shortfalls for future dividends during economic downturns.

This helps explain, at least partially, why Quaker Chemical looks like an overvalued stock based on this approach. Nevertheless, a dividend discount analysis is still a helpful tool in combination with the understanding that it calculates a conservative intrinsic value estimate. Meaning an extremely attractive opportunity would be a stock where (1) a dividend discount model is appropriate and (2) shares looks undervalued based on its future dividends.

Note that there are a number of fundamental factors I have not considered in this analysis. I recommend that you continue your research on Quaker Chemical to gain a better understanding of its future prospects.

As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.

Can Dividend Investors Find Value In Centurylink Inc (NYSE: CTL) Stock?

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Centurylink Inc (NYSE: CTL) has distributed 104.6% of its profits in the form of dividends over the last twelve months making the stock a prime candidate to be valued using a dividend discount analysis. Operating as a telecom company paying a dividend yield of 11.6%, could the large-cap stock be trading at an attractive valuation? Let’s take a look at the future dividend potential of Centurylink to see if there is any catalyst for a price change.


Application Of The Dividend Discount Model

The Dividend Discount Model (DDM) is a dividend-based valuation model that estimates the present value of a stock based on assumptions about its future dividend performance.

But before discussing the assumptions used in my dividend discount model for Centurylink, it’s first helpful to determine if this is actually an appropriate technique to be used when estimating its fair value. Many analysts find it difficult when trying to figure out the correct valuation methodology for a given company or are biased towards one specific approach. This is often a mistake which can negatively impact investment decisions and result in trading losses or missed opportunities. No two companies are the same and every business consists of unique characteristics that may require you to adjust your analysis.

Understanding leverage trends is the first step when determining what valuation analyses are relevant for a given company. When a company’s leverage doesn’t fluctuate or is expected to remain stable over time, then an equity valuation model (e.g. equity DCF, DDM) will be the most appropriate valuation technique. The reason for this is because when leverage is stable, interest expense on debt can typically be projected with much more reliability.

How do we check if a company’s leverage has been fluctuating or is expected to do so? This isn’t always straightforward but checking recent debt ratio trends can be a good indicator. Centurylink’s debt to equity ratio has been relatively consistent over last few years with a range spanning only 16.7%. This suggests that an equity valuation model is a suitable technique when valuing the company’s shares. Now does it make sense to use a dividend discount model knowing that an equity valuation technique is an appropriate methodology?

The next step is to determine if Centurylink pays a dividend and if so, is its payout ratio relatively high (typically above 70%)? The table below provides this information in more detail.

Centurylink Payout Ratio Table

Source: Centurylink dividend discount model

Centurylink distributed a total of $1,453 million in cash dividends to shareholders in its most recent fiscal year Dec-17 which represented a payout ratio of 104.6%. It appears that the company meets both criteria. Therefore, it is fitting to apply a dividend discount model when calculating the intrinsic value of Centurylink.


The first step in building a dividend discount model is to forecast net income since forecasting dividends directly can be difficult. So let’s create a net income forecast for the next five years and use that as the basis for projecting future dividends.

Finbox.io applies consensus Wall Street estimates for the net income forecast when available. For the next fiscal year 2018, profits are expected to decrease -12.2%, then grow 9.7% in 2019 and rise 5.9% in 2020.

Centurylink Net Income Growth Chart

Source: Centurylink Projected Net Income Growth

I use the projections above to serve as the basis for my dividend projections. The next step is to forecast the company’s payout ratio. In my estimates shown in the table below, I select a 90.0% payout ratio in 2018 and hold it steady there throughout the remainder of my projection period.

Centurylink Dividend Forecast

Source: Centurylink dividend discount model


Calculating Centurylink’s Intrinsic Value

Finally, we can now calculate Centurylink’s intrinsic value by present valuing its forecasted dividends. Note that we apply the company’s cost of equity to discount the future dividends since these payments are made to common shareholders or equity owners. I used finbox.io’s Weighted Average Cost of Capital (WACC) model to help arrive at an estimate for the company’s cost of equity.

I determined a reasonable cost of equity for Centurylink to be 13.4% at the midpoint. An updated cost of capital analysis using real-time data can be found at finbox.io’s Centurylink WACC model page.

Centurylink Dividend Fair Value Conclusion

My dividend forecast and cost of capital assumptions imply a fair value per share for Centurylink of $10.12, -45.5% below its current stock price of $18.50. Therefore, CTL appears to be an overvalued stock and not necessarily a good entry point opportunity.


Conclusion: Dividends Don’t Support Stock Price

Finding the true value of a company can sometimes be difficult but determining an appropriate valuation methodology should not be. Knowing when and when not to use the dividend discount model will help in your investment decision making process.

But it is important to note that a dividend discount model will inherently undervalue a company’s stock. This is typically the result of the payout ratio assumption being less than 100% implying some cash leakage. In reality, this excess retained cash is usually paid out to shareholders as special dividends or to make up for cash shortfalls for future dividends during economic downturns.

This helps explain, at least partially, why Centurylink looks like an overvalued stock based on this approach. Nevertheless, a dividend discount analysis is still a helpful tool in combination with the understanding that it calculates a conservative intrinsic value estimate. Meaning an extremely attractive opportunity would be a stock where (1) a dividend discount model is appropriate and (2) shares looks undervalued based on its future dividends.

While a dividend discount analysis on its own is not necessarily indicative of a stock’s intrinsic value, it does provide helpful insights. I recommend that investors continue their research on Centurylink to gain a better understanding of all the factors driving its share price.

As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.

Why Chevron Corporation’s (NYSE: CVX) Dividend Potential Should Concern Investors

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Chevron Corporation (NYSE: CVX) is currently paying investors a below average dividend yield of 3.6% while the Energy sector median stands at 5.4%. Even though this makes Chevron look uninviting relative to its peers, it’s useful to understand the company’s future dividend potential. Will Chevron’s bottom line be the main catalyst driving future growth or maybe its payout ratio? Understanding these components and how they impact value may change your mind on the company’s future prospects.


Is A Dividend Analysis Appropriate?

Dividend Discount Model (DDM) is a way of valuing a company based on the theory that a stock is worth the discounted sum of all of its future dividend payments.

However, before walking through my dividend analysis for Chevron, it’s first helpful to determine if this is actually an appropriate technique to be used when estimating its fair value. Many analysts are often biased towards one specific valuation approach which is typically a mistake that can negatively impact investment decisions and result in trading losses or missed opportunities. Every company has unique characteristics that may require you to adjust your analysis.

Understanding leverage trends is the first step when determining what valuation analyses are relevant for a given company. When a company’s leverage doesn’t fluctuate or is expected to remain stable over time, then an equity valuation model (e.g. equity DCF, DDM) will be the most appropriate valuation technique. The reason for this is because when leverage is stable, interest expense on debt can typically be projected with much more reliability.

How do we check if a company’s leverage has been fluctuating or is expected to do so? This isn’t always straightforward but checking recent debt ratio trends can be a good indicator. Chevron’s debt to equity ratio has stayed relatively stable over last few years hitting a low of 25.1% in December 2015 and a high of 31.4% in December 2016. This suggests that an equity valuation model is a suitable technique when valuing the company’s shares. Now does it make sense to use a dividend discount model knowing that an equity valuation technique is an appropriate methodology?

We now must determine if Chevron pays a dividend and if so, is its payout ratio relatively high (typically above 70%)? This helps figure out if the company distributes the majority of its profits to shareholders in the form of dividends.

Chevron Payout Ratio Table

Source: Chevron dividend discount model

Chevron paid out a total of $8,132 million in cash dividends to shareholders in its most recent fiscal year Dec-17 representing a payout ratio of 88.4%. Therefore, it is fitting to use a dividend discount model when calculating the intrinsic value of Chevron stock.


How To Project Chevron’s Dividends

Since forecasting dividends directly can be difficult, the first step in building a dividend discount model is to project net income. So let’s create a net income forecast for the next five years and use that as the basis for our future dividends.

Applying consensus estimates, Wall Street is projecting a mediocre growth rate in the company’s bottom-line over the next five years. Net income is expected to grow at an average annual rate of 10% bringing net income to $14,612 million by fiscal year 2022.

Chevron Net Income Growth Chart

Source: Chevron Projected Net Income Growth

I apply the net profit estimates above to drive my dividend forecast. The next step is to project the company’s payout ratio. In my estimates shown in the table below, I select a 41.0% payout ratio in 2018 and hold it steady there throughout the remainder of my projection period.

Chevron Dividend Forecast

Source: Chevron dividend discount model


Discounting Chevron’s Future Dividends

The final step is to present value the forecasted dividend distributions using a discount rate. I used finbox.io’s Weighted Average Cost of Capital (WACC) model to help arrive at an estimate for the company’s cost of equity.

I concluded a reasonable cost of equity for the company to be 9.5% at the midpoint. Although I don’t walk you through the CAPM assumptions that got me there, you can view the calculations using real-time data at finbox.io’s Chevron WACC model page.

Chevron Dividend Fair Value Conclusion

In conclusion, my dividend discount model calculates a fair value per share for Chevron of $90.94, -27.3% below its current stock price of $124.22. Therefore, CVX appears to be an overvalued stock and not necessarily a good entry point opportunity.


What This Means For Investors

An important component of the dividend discount model that investors should understand is that the technique will inherently undervalue a stock. This is typically the result of the payout ratio assumption being less than 100% implying some cash leakage. Meaning the approach does not capture value that would otherwise build up as cash on the balance sheet. In practice, this excess retained cash is usually paid out to shareholders as special dividends or to make up for cash shortfalls for future dividends during economic downturns.

This helps explain, at least partially, why Chevron looks like an overvalued stock based on this approach. Nevertheless, a dividend discount analysis is still a helpful tool in combination with the understanding that it calculates a conservative intrinsic value estimate. Meaning an extremely attractive opportunity would be a stock where (1) a dividend discount model is appropriate and (2) shares looks undervalued based on its future dividends.

Although a dividend discount model on its own is not necessarily indicative of a stock’s fair value, it does offer a number of useful insights. This valuation should only be the start of your analysis in relation to your total research. I recommend that you continue your review of Chevron to gain a better understanding of its underlying fundamentals.

As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.

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