Dividends And Stock Valuation: A Study From The Nineteenth To The Twenty-First Century (Page 27 of 45) in pdf

Dividends And Stock Valuation: A Study From The Nineteenth To The Twenty-First Century Page 27

change as economic conditions change and our different models capture this in different ways and thus

have different strengths and weaknesses.

The previous results suggest that there are differences between the estimated and implied costs of

equity which may change over time because the implied cost of equity is able to react more rapidly to

changing economic conditions. In Table 8a we study the results from the regressions of our economic

factors on the implied costs of equity. For the implied costs of equity using the DDM and GGM (the first

and second panels respectively), we find that the implied cost of equity using the DDM is more sensitive

to our economic factors than is the cost of equity estimated using the GGM – the directions of the

relationships are all the same, it is only the magnitudes which are smaller for the GGM. This is likely due

to the fact that the cost of equity estimated using the GGM is already, at least somewhat, corrected for

changes in the economy through the use of the GNP as our estimate for the future expected growth rate.

For the implied cost of equity we find that it increases as our measures of economic performance suggest

a future decline in the performance of the economy (i.e,, as the default premium, term structure and CPI

all increase).

We also find that the implied costs increase as the momentum factor increases. This suggests that

the implied cost of equity increases following a run up in equity prices – it could be related to the prices

being lagged in the momentum factor and thus signaling a future turnaround in the economy so that the

cost of equity will start to increase going forward. Finally, the P/E ratio is negatively related to the

implied cost of equity. This suggests that as investors are starting to more highly value earnings, this is

an indicator that the economy is expected to perform well in the future and therefore the required return

on equity investments is able to decline at these times.

The other major input into our fundamental valuation models that we need to estimate and

assume specific values is the expected growth rate for dividends. In Table 8b we consider how the

estimated and actual growth rate of dividends depend on economic conditions. The actual growth rate in

dividends is negatively related to the default premium and the momentum factor. This suggests that as

the default premium is increasing and thus the economy is viewed to be starting a bad stage, the dividends

Dividends And Stock Valuation: A Study From The Nineteenth To The Twenty-First Century Page 27