Pick a company that pays dividends, then calculate the expected growth rate of your company using the CAPM.
Once this task is complete, calculate the expected growth rate using the Constant Growth (or Gordon Growth) Model.
To complete this task, follow these steps:
1. Choose a company that pays dividends: Select a publicly traded company that regularly pays dividends. Examples of such companies include Procter & Gamble, Coca-Cola, Johnson & Johnson, and Walmart.
2. Determine the required inputs for the CAPM: The CAPM (Capital Asset Pricing Model) calculates the expected growth rate of a company using the following inputs:
- Risk-free rate: This is the interest rate on a risk-free investment, such as a government bond. For example, assume a risk-free rate of 2%.
- Market risk premium: This is the excess return an investor expects to earn by investing in the overall market rather than a risk-free investment. As of today, it is around 5% to 7%.
- Beta: Beta measures the stock's sensitivity to market movements. It is a measure of systematic risk. You can find the beta of a specific company from financial websites or databases. For example, assume a beta of 1.2.
3. Calculate the expected return using CAPM: The CAPM formula is:
Expected Return = Risk-free rate + (Beta × Market risk premium)
Assuming a risk-free rate of 2% and a market risk premium of 5%, the expected return would be 2% + (1.2 × 5%) = 8%.
4. Determine the required inputs for the Constant Growth Model: The Constant Growth (or Gordon Growth) Model calculates the expected growth rate of a company using the following inputs:
- Dividends per share: Identify the company's latest dividend per share. For example, assume a dividend per share of $2.5.
- Required rate of return: This is the return investors expect to earn on the stock. It can be calculated using the CAPM or other methods. For this example, assume a required rate of return of 8% (as calculated in step 3).
- Expected dividend growth rate: This is the expected rate at which the company will increase its dividends per share over time. This rate should be sustainable and reasonable. For this example, assume a growth rate of 4%.
5. Calculate the expected growth rate using the Constant Growth Model: The Constant Growth Model formula is:
Expected Growth Rate = Dividend Growth Rate
Assuming a dividend growth rate of 4%, the expected growth rate using the Constant Growth Model would be 4%.
It's important to note that these calculations provide estimates and may not precisely reflect the future growth rate of a company. They are based on assumptions and historical data, which may change over time. Additionally, other factors such as economic conditions, company performance, and industry trends should also be considered when evaluating growth rates.