Valuation of Declining Growth Stock

by Ryan Menezes, studioD

During a company's early years, not only do its dividends grow annually, but the dividends' growth rate itself increases. This supernormal growth period gives way to a period of stable, fixed growth, and if the company then contracts, it experiences negative, or declining, growth. Investors value a declining growth stock poorly because its price will drop over time. Nonetheless, such a stock does have value so long as its dividends can exceed the shares' capital losses.

Calculate each year's expected dividends from the stock's rate of decline. For example, suppose that each share initially offers annual dividends of $1.02. Suppose further that each year's dividends are 0.8 of the previous year's and that you plan to hold the stock for three years. Multiply $1.02 by 0.8 to get $0.816, and multiply $0.816 by 0.8 to get $0.653.

Add one to your required rate of return from the investment. For example, suppose that you require an 11.5 percent rate of return. Add 1 to 0.115 to get 1.115.

Raise this multiplier to the power of the number of years until each dividend payment. Raise it to the power of 1 for the first year to get 1.115. Raise it to the power of 2 for the second year to get 1.243. Raise it to the power of 3 for the third year to get 1.386.

Divide each year's predicted dividend by its respective revised multiplier from the previous step. Continuing the example, divide $1.02 by 1.115 to get $0.915, divide $0.816 by 1.243 to get $0.656 and divide $0.653 by 1.386 to get $0.471.

Add the values from Step 5: $0.915, $0.656 and $0.471 make $2.042, or approximately $2.04. This is the value of each share of the stock.

About the Author

Ryan Menezes is a professional writer and blogger. He has a Bachelor of Science in journalism from Boston University and has written for the American Civil Liberties Union, the marketing firm InSegment and the project management service Assembla. He is also a member of Mensa and the American Parliamentary Debate Association.

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