6.5 Estimating Dividends

The dividend to be estimated is the current or time 0 dividend.  The dividend model then grosses up this dividend by one plus the estimated growth rate over time.

Estimating Current Dividends:

In the direct form the dividend is the latest (or announced) quarterly dividend multiplied by four to get an annual dividend.  This provides a reasonable estimate of the current annual dividend rate because most company's dividend policy is sticky in the sense that it slowly steps up over time.  Another popular method for estimating the current dividend rate is to calculate the total dividends paid out in the trailing twelve months.  We call both of these the “simple” model, in which you have a direct estimate of the dividends.

In the earnings form, dividends equal earnings times the payout ratio.

In the ROE form, dividends equal the book value times the ROE times the payout ratio:

In the ROA form, the ROE is calculated as:

where r is the interest rate on debt and t is the corporate tax rate.  Dividends are then calculated from ROE as d = BV*ROE*PR as described above.

In the DuPont form, the ROE is the product of the terms in the DuPont decomposition:

ROE=Profit Margin * Asset Turnover Ratio * Financial Leverage Ratio, and the dividend is as before.  In this form the analyst is consider the drivers of ROE whilst assessing current dividends.  This is because although dividend policy is sticky from time to time they will change and companies will cut dividends if necessary. 

For example, GE was one of the great dividend stories for 2010.  GE's dividend rate went from $0.31 per quarter to $.10 per quarter because profit margin's no longer supported their old dividend payouts.