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Technology Stocks : Lucent Technologies (LU)

LU 2.560

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2:06 PM EST

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To: John Malloy who wrote (9107)	8/10/1999 4:39:00 PM
From: Chuzzlewit	Read Replies (1) of 21876

John, First, let me thank you for raising an issue that is too often ignored by investors. I have been grappling with this issue for years and have no really good solution to valuation. I have no problem with firms that do not pay dividends. In that case the only cash flows to discount are the net proceeds when the investor sells the stock and capital gains taxes. And how do you calculate that value? BTW -- that value is often referred to as a stub value. You said I have developed a simple way to translate that [equity] growth rate forecast into the equivalent forecast of equity per share. But you have provided no details nor the theoretical underpinnings for the key assumption that a stock's value is related to the growth in equity per share. Do you have empirical evidence that it is correct? The problem of how to handle firms that do not pay dividends only arises with the venerable Dividend Discount Model, which says that a stock is worth the current dividend divided by the difference between the discount rate and the dividend growth rate. True (except that the model uses cost of equity as the discount rate), and that's why using free cash flows is preferable to dividends, and is applicable to any company with economic profits. A steady-state model like the DDM is not appropriate for growth stocks. Again true, but if you estimate each FCF over the investment horizon you can easily get around this problem using a DCF model. As growth slows firms need less of earnings to finance the slower growth and have something left to begin paying dividends. Those are the dividends that are missing from the DDM. I suspect that this is the FCF concept I've been driving at. But if this is your focus, why do you consider equity per share as important? Think about MSFT for a moment. Dividends are nil, but the company is sitting on a huge amount of cash -- $42BB which has been built up over the years from FCF. It is the projected rate of that build-up derived from operations which IMO should be the basis for valuation. Everything else is irrelevant. TTFN, CTC

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