How to Calculate Stock Value Based on Dividends
When you buy a stock, you may wonder how was that stock priced. Well, there is many ways to price a stock, but what I always like to do is explain to people it's really based on the dividend.
Because remember, when you're buying an investment or a stock, what you're really buying is cash flow at some point. And that cash flow is usually given to a shareholder in the form of a dividend. And we have a method to value dividends.
And let's take Ford Motor Company in 1920. If I was to value that company, let's assume that they had a $10 dividend. That dividend, because Ford Motor Company's still here, I'd have to calculate that dividend in perpetuity, meaning that it would never end. And then I would sell the stock at some point in the future, which would be a long time, and then discount.
That would be the value. But that formula is extremely complicated. What somebody has done who I don't know, a mathematician, he's broke down the formula and made it very simple so you can calculate the value of the stock based on its dividend.
And it's simply...it's the dividend rate divided by the cap rate. For example, let's say the dividend is $10, and your cap rate, what you expect to earn, is 15%. That means the stock is worth $66.67, very simple.
It sounds too simple to be true, but this works. And a lot of times when you look at a stock and you actually apply this method, you'll find out that it comes pretty close to the value that you're buying Ford.
And this also can be applied to private companies. If you just assume what you're going to be getting and divide it by a cap rate, it will give you a value for the company. Something we do in most of our valuations. It's simple. It's interesting and if you have any questions on the valuation dividend method, feel free to give me an email.