Thursday, October 16, 2014

Gordon Growth Model and viability of Apple and Microsoft Stock Prices


Question:   The Gordon Growth Model asserts that the value of a stock can be modeled as

P = D/(k-g)

Where D is the expected price on a stock.  

D is next year’s expected annual dividend per share

k is the investor’s discount rate

g is the expected growth in dividends.


Use the Gordon Growth Model to compare the viability of the current stock prices for Apple and Microsoft.

Here is a discussion of the Gordon Growth Model:


Here is my assessment of Microsoft and Apple.  (I am using current market prices for P and current dividends for expected next year’s dividends and a 0.12 discount rate for investors in both companies.

Input for Gordon Dividend Growth Model Calculation
Apple
Microsoft
Price of Shares
$97
$43
Expected Dividends Per Share
$1.88
$1.24
Discount Rate
0.12
0.12



Given these admittedly arbitrary assumptions, what is the value of g (the expected growth in dividends) that is consistent with current market prices for the two stocks?


Answer:

Rearrange the Gordon Growth Model equation to solve for g.

g= (Pk-D)/P


Below is the calculation for g and the check for the calculation.


Calculation for g and check of calculation
Apple
Microsoft
P
Price of Shares
$97
$43
D
Expected Dividends Per Share
$1.88
$1.24
k
Discount Rate
0.12
0.12
(Pk-D)/P
g
0.101
0.091
D/(k-g)
Check
$97
$43


Observations:

Based on the Gordon growth model and my assumptions I calculate the dividend growth rate consistent with current stock price.

The model finds g=0.101 for Apple and g=0.091 for Microsoft.

What projection of future dividend growth is more realistic?

The answer I believe is that at this point in time Apple is much better positioned than Microsoft.      

Why: 

The current dividend yields for Microsoft and Apple are 2.9% and 1.9& respectively.  Based on these yields Apple has more upside on dividends.

Microsoft is already paying more of its income on dividends than Apple – payout ratios are 41% for Microsoft and 29% for Apple.


Why I could be wrong on this:  

Microsoft has more cash per share than apple $10.31 for Microsoft and $6.33 for Apple.



Financial Statistics are from Yahoo:  




Other interesting posts on Apple and Microsoft:


Yesterday I looked at wealth accumulated by an investor who bought 100 shares in the Microsoft and Apple IPO.







Interestingly, the Microsoft beat the Apple IP by a lot.  The Windows franchise was incredibly dominant for a long time and the finance people at Microsoft were very good at making sure previous investors were not diluted down. 


However, Apple got hot with new products – ipod, ipad, iphone, and now even icash.  The struggle continues.











 



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