Larry, Moe, and Curley are brothers. They’re all serious investors, but each has a different approach to valuing stocks. Larry, the oldest, likes to use a 1-year holding period to value common shares. Moe, the middle brother, likes to use multiyear holding periods. Curley, the youngest of the three, prefers the dividend valuation model.
As it turns out, right now, all three of them are looking at the same stock—American Home Care Products, Inc. (AHCP). The company has been listed on the NYSE for over 50 years and is widely regarded as a mature, rock-solid, dividend-paying stock. The brothers have gathered the following information about AHCP’s stock:
Current dividend (D0) = $2.50/share
Expected growth rate (g) = 9.0%
Required rate of return (r) = 12.0%
All of them agree that these variables are appropriate, and they will use them in valuing the stock. Larry and Moe intend to use the D&E approach; Curley is going to use the constant-growth DVM. Larry will use a 1-year holding period; he estimates that with a 9% growth rate, the price of the stock will increase to $98.80 by the end of the year. Moe will use a 3-year holding period; with the same 9% growth rate, he projects the future price of the stock will be $117.40 by the end of his investment horizon. Curley will use the constant-growth DVM, so his holding period isn’t needed.
a. Use the information provided above to value the stocks first for Larry, then for Moe, and then for Curley.
b. Comment on your findings. Which approach seems to make the most sense?