forthcoming journal of applied strongfinancestrong.pdfVIP

The Dividend Discount Model in the Long-Run: A Clinical Study By: * Stephen R. Foerster and Stephen G. Sapp Richard Ivey School of Business The University of Western Ontario London, Ontario, Canada, N6A 3K7 First Version: February 26, 2004 Current Version: September 18, 2005 Forthcoming Journal of Applied Finance Abstract Finance professionals frequently value assets using fundamental valuation methods which discount the expected cash flows received by investors. Using information on the share price, dividend payments and earnings for a single firm over a period of more than 120 years, we compare the actual share price to the expected price—calculated using several of the most commonly used fundamental valuation methods. Since these methods depend on the estimation of inputs—such as the discount rate and growth rate—we discuss the sensitivity of the expected prices to different estimation techniques and the relevant assumptions across various economic conditions. Over our entire sample period, we find that dividend- based models perform well at explaining actual prices; they perform better than commonly used earnings- based models (such as the Fed Model). JEL Codes: G21, G35 Keywords: Dividend Discount Model, Valuation * Paul Desmarais/London Life Faculty Fellowship in Finance (Foerster) and MBA Class of 1989 Facul