A zero growth dividend is a dividend that pays a uniform dividend that does not experience growth over time. Preferred shares are generally zero growth dividend paying securities.
The present value of a stock is broadly considered the sum of the discounted future cash flows. Dividends are considered the future cash flows as the appreciation of a stock is not realized unless sold. Since the stock is held with no maturity date, one could consider a stock to be a perpetuity, in that its dividends are to be received infinitely.
The present value of a share with no growth formula is more conceptual than forcefully implemented in every circumstance. The general idea is that a share is essentially like any other form of investment and should be valued based on future cash flows.
The dividend payout is the value of dividends paid out by the zero growth dividend security. They remain constant throughout the life of the share and do not change to account for growth.
The required rate of return, also known as the discount rate, is the rate of return required by an investor from a security or share in order to consider investment within the commodity.
The present value of zero growth dividend issuing share is the value the security in today’s dollars. It represents the amount expected to pay to purchase, or be paid if selling, for the zero growth dividend security.
The formula for the present value of a stock with no growth shown at the top of the page theorizes that the stock is a perpetuity where dividends will be received on an ongoing basis for an unending period of time. Dividends would be denoted as cash flows in the perpetuity formula. Assume you have the opportunity to invest in a zero growth dividend security that pays a dividend of $5 annually and you hold an expected rate of return of 10%. Using the zero growth dividend formula, the value of the security can be valued as follows:
P0 = D / r
P0 = 5 / 0.1
P0 = $50
Using the zero growth dividend formula, the present value of the security is $50 per share. Assuming it is fairly or overvalued, it presents a fair investment that would pay a regular dividend annually.
As zero growth dividend securities are effectively perpetuities, they hold similar advantages and disadvantages in common. Zero growth dividend securities are assumed to have an infinite life and pay dividends until such point as the company dissipates or the shares are sold, assuming the company makes profits to pay dividends regularly from period to period. Though zero growth dividend securities are rare, an assumed, yet conditional, regular stream of income provides an advantage to investors.
The zero-growth model assumes that the dividend always stays the same i.e. there is no growth in dividends. Therefore, the stock price would be equal to the annual dividends divided by the required rate of return.
This is basically the same formula used to calculate the Present Value of Perpetuity and can be used to price preferred shares, which pays a dividend that is a specified percentage of its par value. A share based on the zero-growth model can still change in price if the required rate changes when perceived risk changes, for instance.
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