Thursday, September 04, 2014

Forecasting Dividends - Part 1

Forecasting is difficult, nigh on impossible in fact, however in order to have a basis for deciding what to do right now - we need to have some grasp on what may happen in the future.

Stocks are valued by the market's expectations of future dividend payouts.

As a mind experiment let's assume determinism and forget about uncertainty for a while.


We have Acme Co.  The market knows that the company will stick around for the next 100 years; that it will pay out a dollar dividend per year for the duration of its life.

Let's also assume that the market values receiving a dollar now the same as a dollar receive at any point in the future.

How much will a stock in Acme Co. be valued by the market?  $100, of course.

Assuming everything stays the same, how much will Acme Co. be valued at next year? (i.e. the 'one year forward' price)


The difference between the forward price and the current price is the dividend paid over the next year: $1.

This is the value we would like to predict in the real world.


Now lets add back in all the complexity which we assumed away.

Of course we never know how long a company will survive; a company could kick the bucket next year or in a hundred years.

We can only guess at what dividends will be paid out in the future.

And, importantly, everyone is impatient, of course I'd rather dollars sooner rather than later!

Last, but not least, nothing stays the same.  Shit happens, as the saying goes.


It seems we have hit a road block.


We had a mind experiment that makes sense.  We add in a bunch of uncertainty and now we are back to square one.

It's like we have a 'mental equation'; to which we just added a slew of unknowns and all of a sudden it's all unsolvable.


Tune in next week for more!