The financial institution dividend discount model uses future dividends to find the implied share price. This model is based on the theory that future dividends discounted to the present time is the intrinsic value or share price of the company.
This template includes two types of dividend discount model:
- DDM - Method 1 based on return on assets
- DDM - Method 2 based on GDP
Dividend Discount Model - Method 1
The first method of the financial institution dividend discount model takes the average return on assets to forecast future net income of a financial institution. The ROA also forecasts the risk-weighted assets (RWA) which are used to calculate the terminal value. The dividend for this financial institution is extremely stable as dividend growth occurs every other quarter. This was accounted for as the growth rate is only applied every other quarter. Since this method uses quarterly dividends, the year fraction function is used to discount the dividends.
Dividend Discount Model - Method 2
The second method of the financial institution dividend discount model uses the payout ratio and net income. The net income is forecasted by driving the main balance sheet items such as loans and deposits using GDP projections. After projecting the loans and deposits, the net interest income is calculated. By adding net interest income with non-interest income and subtracting loan losses, the net income for the next five years is projected. Combining the present value of the implied dividends from the payout ratio with the present terminal value creates the total intrinsic value of the company. Dividing that value by the total share outstanding gives the implied share price.
Why does it matter?
The financial institution dividend discount model will help users understand the different ways of discounting dividends for financial institutions. Users can change assumptions or financial statement data to get the intrinsic value of other institutions. This will help investors get a better idea of the implied share price of a company.