14.15: Capital Gains

It is interesting to note that, if G > 0, the model will automatically generate capital gains. Here again is our formula. Below is a problem whose resolution illustrates the model’s automatic generation of capital gains.

G = 5% The Dividend’s Constant Growth Rate

We observe that $22.05 / $21 = 1.05. That is to say that next year’s price will be greater than last year’s by 5%, or the same as the stock’s growth rate (again, assuming a constant pay-out ratio).

We often say that a stock is “ahead of itself,” if the rate of growth in price exceeds the dividend – or earnings – growth rate (assuming a constant pay-out ratio).

The following should help summarize some relevant concepts.

1. Complete the empty cells, given the data noted below for a stock. The basic formula for the Dividend Discount Model is:

2. Once again, complete the spreadsheet, given the data noted for a particular stock.