Can someone explain to me the alternative cost of equity formula:
Cost of Equity = Div. return + Div. growth rate
I would just like to know a little bit of the intuition behind it.
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Nt sure If that is cost of equity but basically DDm says price of stock is a function of its div and div growth. Ie the price of the stock represents existing div yield and div growth
Similar to saying inverse p/ e is ur cost of equity
Sorry not similar basically same. Ie a PE of five means I have approx 20 percent cost of equity bc I'm selling every dollar of future earnings for 5 bucks
Rough explanation but you get idea
You could say that dividend yield is a reasonable proxy for cost of equity. I don't know that you need to do anything with expected growth of dividends because that should be impounded into the cost of the stock. You could also do this to determine the market risk premium (average dividend yield of S&P or something to that effect).
I think you could also think of the price of a stock = earnings/(cost of equity - long term growth).
Transpose that formula to:
cost of equity = (earnings/price)+long term growth
The cost of equity is simply the opportunity cost of investment for a potential investor
Intuitively, all an investor does when he buys a share of a company is purchasing a share of all future dividends from that company into perpetuity. In practice, they receive dividends and also capital gains, but capital gains are simply the market placing a higher value on what they believe that company's perpetual dividend stream will be in the future.
Ultimately all returns to the investor are basically expected dividends for each share in perpetuity. The opportunity cost, and thus the cost of equity is the market price of the share plus the discounted value of those all dividends in perpetuity. Dividend return simply being the portion of the stock price deriving from next year's dividend
Hope that helps a bit. Have to leave but I'm sure others can fill in any gaps
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