## 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?

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.