Stock Valuation

Following up on this post , a modification is offered to the traditional linking of fundamental stock values and anticipated dividend streams.

It is usually claimed that the fundamental value of a stock is equal to the summed net present value of all of its estimated future dividends. For a number of reasons, this cannot be a complete description. For example, even a fully successful biotech research firm may never pay a dividend, but be acquired in a buyout by another firm if its research bears fruit. Also, it is not really the dividends actually paid that count, but the ability to pay them if and only if that payment is deemed to maximize shareholder value.

A more complete description of fundamental stock valuation would be something like the following :

The fundamental value of a stock holding can be estimated by the sum of the net present values of a stream of dividend payments, augmented and terminated by some future liquidation event.

The future liquidation event may include :

1. Sale of the stock holding.
2. Merger or acquistion of the company with or by another company
3. Actual liquidation of the company for any residual cash value that may reside with the shareholders.
4. Other

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Your definition is

Your definition is wrong.

The fundamental value of a security (any security, not just stock) is the net present value of all future cash flows, not just all future dividends. This short-circutits your phantom problem of non-dividend-paying stocks and incorporates, e.g., stock buybacks, tender offers, spin-offs and spin-outs, callable bonds, and being acquired by another company.

You had the right framework, definitely, just some bad inputs.


Yep, I agree with Kip.

Yep, I agree with Kip. Except his generalization is not general enough. There can be non-cash benefits for a stock, like tax advantages, the right to vote on the company, entertainmnent, etc. We can simply say that the value of a stock, like the value of anything else, is the NPV of the future stream of costs and benefits associated with it. Now we've abstracted away everything that makes a stock a stock, so we could go back in and mention the specific costs and benefits that most stocks have, acknowledging that the general formula is the right one.

And note that the "traditional valuation" is really not that bad, since most of the value of most stocks comes out in dividends. It's just incomplete, and for some stocks will fail badly.