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Dividend Discount Model Valuation- Sotheby’s

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Introduction Dividend Discount model is a valuation for stock prices. We can make estimates of current stock prices with the help of this model. In the dividend discount model expected dividends are discounted at the required rate of return to find the present value of the dividend and on the basis for calculating the price of a stock that an investor willing to pay today for the stock. “The simplest model for valuing equity is the dividend discount model (DDM)—the value of a stock is the present value of expected dividends on it” (Damodaran, A- 2012). I have selected Sotheby's (Stock Ticker = BID) for this essay. We will try to find the current stock price of Sotheby’s with the help of dividend-discounted model. I have taken all required information for the calculation from Yahoo finance and the annual report for the year 2017 from the company’s website. We will also need additional information, Market risk premium rate, Risk free rate for the discounted dividend model. On the basis of market risk premium rate and riskfree rate we can estimate of our required rate of return to discount the dividend.

Analysis As per the Excel calculation, the stock value under constant growth model is $13.33. Variable growth model gives us the stock price of $13.56 for Sotheby's. The book value (BV) is $11.76, which is close to our calculated price for Sotheby's. However, Sotheby’s current price is $39.92, which is much higher compared to the models calculated price. Therefore, a lower intrinsic value compared to the current market price indicates that stock is overvalued. The market price of a stock usually varies to some extent from its BV. However, if investors demand much for a particular stock is high, the market price of the stock rises above the BV and therefore, the stock may appear temporarily overvalued. Additionally, some assumptions have

Dividend Discount Model Valuation- Sotheby’s

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been made while calculating the stock price using the dividend discount model. One of the major assumptions is growth rate of the dividend, the growth rate of the dividend 2.5% to 3.5%. However, there is no visible trend in the dividend growth based on the analysis from the previous years. The divided paid by the company fluctuates widely and does not form any specific pattern; therefore, we have to assume the dividend growth rate to complete the calculations. Market risk premium rate is also assumed at 5.50%. It is not possible to calculate exact market risk premium rate as it depends on many factors and may keep changing from time to time. According to ("BID : Summary for Sotheby's - Yahoo Finance," n.d.), Sotheby’s beta is 1.90. “The value of a share is given by the dividend discount model as a simple function of future dividends; but the actual determination of the share price is rarely based upon the direct estimation of these future dividends” ("Modified Dividend Discount Model," 2015). Current market price of the stock is $39.92 ("10-Year T-Note Futures Quotes - CME Group," n.d.), which is much higher than its BV and price calculated by us using the dividend discount model. Therefore, Sotheby’s stock is overvalued, indicating that investors have a positive outlook for the company’s future. Investors are willing to invest in the company even at higher prices when the outlook of the company is positive. There are many factors to consider when there is a disparity in price. A major factor is market sentiments “the general feeling about the climate of the market as expressed by the direction of market prices” ("Market Sentiment Definition & Example | InvestingAnswers," n.d.), when the market sentiments are positive the price of the stock increases without any valid reason and price drops drastically when market sentiments becomes negative. Also, many assumptions are made when calculating Sotheby’s stock price, while using the discounted dividend model. These assumptions will affect the accuracy of the calculation and change in

Dividend Discount Model Valuation- Sotheby’s

assumptions will change the final stock price dramatically. For example we have taken the growth rate as 2.5% to 3.5% in the absence of a clear and visible trend in the dividend growth. Therefore, changing the growth rate the stock valuation will change. A change in the market risk premium will change the valuation of stock. Apart from this, any positive or negative news or events about the company will cause the current stock price fluctuation, which will be not be covered under the dividend discount model of valuation. In short we can say that some variation between Sotheby’s current stock price and calculated stock price as per the valuation model is bound to happen. Still, the dividend-discounted model is a very useful approach for valuation of the Sotheby’s stock. Stock valuation model offers a benchmark of the relative price differences, which serves as a basis from which to conduct subjective, company-specific analysis and to make investment decisions; but valuation models are not used exclusively, in themselves, to value shares. Conclusion It can be concluded that Sotheby’s current stock price is overvalued compared to the stock price calculated using the dividend discount model. Therefore, investors have a positive outlook for Sotheby’s future, and additional analysis should be prepared for such variations and to make informed investment decisions. The model tells investors willing to pay more than BV if earnings are higher than expected, and less BV if earnings are lower than expected. In other words, the investors or security analysts need to be careful and knowledgeable in choosing different valuation methods. Particularly, this valuation method has different inputs and assumptions to be included so that the outputs are factual.

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Dividend Discount Model Valuation- Sotheby’s

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References BID : Summary for Sotheby's - Yahoo Finance. (n.d.). Retrieved from https://finance.yahoo.com/quote/BID?p=BID Damodaran, A. (April 2012). “"Investment Valuation: tools and techniques for determining the value of any asset," John Wiley. Investor Relations | Sothebys. (n.d.). Retrieved from https://sothebys.gcs-web.com/ Market Sentiment Definition & Example | InvestingAnswers. (n.d.). Retrieved from https://investinganswers.com/financial-dictionary/stock-market/market-sentiment-3990 Modified Dividend Discount Model. (2015, June 1). Retrieved from https://www.omicsonline.org/open-access/modified-dividend-discount-model-2315-78441000156.php?aid=57547 The Reliability of Constant Growth Dividend Discount Model (DDM) in Valuation of Philippine Common Stocks. (n.d.). Retrieved from https://www.omicsonline.org/open-access/thereliability-of-constant-growth-dividend-discount-model-ddm-in-valuation-of-philippinecommon-stocks-2162-6359-1000487-99765.html 10-Year T-Note Futures Quotes - CME Group. (n.d.). Retrieved from https://www.cmegroup.com/trading/interest-rates/us-treasury/10-year-us-treasurynote.html? gclid=EAIaIQobChMI2avNxOza3gIVkImPCh3eiQsQEAAYASAAEgJMUPD_BwE&gc lsrc=aw.ds...