Two-Stage Dividend Discount Model
The stock being examined is Coca-Cola (KO), an American multinational beverage corporation and
manufacturer, retailer and marketer of non-alcoholic beverage concentrates and syrups. The company is
best known for its flagship product Coca-Cola, invented in 1886 by pharmacist John Stith Pemberton in
Columbus, Georgia.
Here is the process of how I examined the stock:
1. I went to Yahoo! Finance & got the estimate of Forward Annual Dividend Rate in dollar terms.
The estimate as of 10.17.2012 (12:47pm) was $1.02.
2. Using the Parameters option on the FTS System main page, I updated the following options:
a. Parameter Type – Dividend Model: 2 Stage
b. Parameter Field – DIV2_D = 1.02
c. Parameter Field – DIV2_G1 = .08 (Updated to reflect the market’s consensus forecast)
d. Parameter Field – DIV2_G2 = .035 (Consistent with the yield curve analysis from
assignment)
3. I received the following values:
a. Implied G1: 0.0116
b. Implied G2: 0.0247
c. Implied D1: 0.1315
d. Implied D2: 0.0706
e. Implied Div: 0.7464
f. Div: 1.02
g. Growth 1: 0.800
h. Growth 2: 0.0350
i. Years: 5
j. Disc 1 (ke 1): 0.0599
k. Disc 2 (ke 2): 0.0599
That is, assuming that the model’s two stage growth rates are: 8% for the first 5-years and then 3.5%
thereafter and given the spot stock price is $37.91, then holding stage 2 growth fixed at 3.5%, the
implied stage 1 growth rate is 1.16% for KO. That is, the implied stage 1 growth rate given price is much
lower than the estimated input for Stage 1 growth. This suggests that KO is currently being
undervalued in the market. Or put alternatively to support a stock price of $37.91 only requires very
conservative stage 1 growth forecast for KO.
In comparison to the original case, which suggested a 10.39% growth rate for the first 5-years and then
4.5% thereafter with a $66.43 stock price & implied a 1.85% implied growth rate, Coca-Cola is still being
undervalued in the market.
Figure 1 - KO Dividend Model
As shown in Figure 1, KO’s intrinsic value is $13+ dollars above the market price, supporting the claim
that KO is being undervalued in the market.
Conclusion: The evidence clearly states that Coca-Cola is being undervalued in the market relative to
current forecasts. As a result, from a long term investors’ perspective, we would rate Coca-Cola as a buy
currently given the implied values from a two stage abnormal growth model.
Recommendation: Buy for a long term investor.
The implied expected return for KO is 6.89% as shown in Figure 1. From this we can forecast KO’s price
in one year’s time to be:
Market Price x (1 + Expected Return) = $37.91 x 1.0689 = $40.52