Dividends And Stock Valuation: A Study From The Nineteenth To The Twenty-First Century (Page 4 of 45) in pdf

Dividends And Stock Valuation: A Study From The Nineteenth To The Twenty-First Century Page 4

implied values for the discount rate and dividend growth rate used in our fundamental valuation methods

across periods characterized by several different economic regimes.

Our study makes three main contributions to the literature. First, we provide a detailed

comparison of the relationship between the valuation one would have obtained using fundamental

valuation methods and the actual price for equity over a long period of time. Using a long time series

allows us to study how investors’ valuations change with economic factors. This allows our study to

complement the growing work in empirical asset pricing which focus on the relationship between asset

returns and economic factors. Second, we investigate several of the assumptions used in our fundamental

valuation methods. Specifically, these models require an estimate of the cost of equity and dividend

growth rate at each point in time, so we investigate how these have changed over time and across

economic conditions. This allows our study to provide new insights into the required rates of return and

levels of growth which are at the heart of work in empirical asset pricing. Third, we combine these results

to characterize how changes in the way investors value dividends are related to changes in economic

conditions.

In our analysis we consider the actual prices and dividend payments for the S&P Composite

Index over the period from 1871 to 2003. Using these data, we calculate the prices that one would have

rationally expected using fundamental valuation methods and the expected future dividend payments. We

then compare the actual and expected prices, as well as the estimated discount rates to the implied values

based on the actual prices and dividend payments over the sample.

Using commonly considered

economic factors such as the default premium, term structure of interest rates, price momentum and

price/earnings multiples at each point in time, we determine the conditions under which the valuation

models can best explain observed prices.

We find that our dividend-based valuation methods perform relatively well at explaining the

actual prices for the S&P Composite Index over our sample period. When considering the differences

between the actual price levels for the Index and the expected prices obtained using the DDM and the

GGM, we find that these differences are frequently and systematically related to changes in economic

Dividends And Stock Valuation: A Study From The Nineteenth To The Twenty-First Century Page 4