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Technology Stocks : Lucent Technologies (LU) -- Ignore unavailable to you. Want to Upgrade?

To: Chuzzlewit who wrote (9092)	8/10/1999 1:32:00 PM
From: John Malloy	Read Replies (1) \| Respond to of 21876

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. 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. If dividends are zero the DDM says the stock's value is also zero and the stock is worthless. That is a consequence of the steady-state assumption built into the DDM. If the dividend payout fraction is zero now the steady-state assumption says it will always be zero. That means the firm never will pay dividends. DDM is right -- if the firm never pays dividends its stock is indeed worthless. A steady-state model like the DDM is not appropriate for growth stocks. Lucent's current 34 %/yr. growth in equity/share will not stay at that high level forever. You have to allow for growth to slow gradually as Lucent?s markets mature. That's why I forecast by drawing free-hand forecast curves. It's an extremely flexible way to allow for slowing growth and the gradual approach to maturity. It frees me from the limitations of steady-state models. My procedure is to draw a free-hand forecast curve for the growth rate of equity per share on a sheet of graph paper. I have developed a simple way to translate that growth rate forecast into the equivalent forecast of equity per share. Multiply any point on the equivalent equity per share forecast by the corresponding point on a free-hand forecast curve for the price/book ratio and you have the corresponding forecast of the stock's price. This is all much simpler than it sounds. Worksheets in my book that do the job. An average investor with a hand calculator can do the worksheet easily. 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 recognize the objections to what the firm's accountants report as stockholder equity. But that is not a problem. Stockholder equity doesn't have to be accurate. It only has to be calculated in a consistent way from one year to the next. As long as it meets the consistency requirement you can build a useful model on equity/share. I don't know what you mean by a "stub value" for a stock. I discount future cash flows at the individual investor's opportunity cost, plus a risk premium. That makes the appropriate discount rate vary from one investor to the next. John Malloy