Aspial Lifestyle Limited (Catalist:5UF) is a specialty retail company that operates in the jewellery and watch segments. The company has been paying dividends to its shareholders since 2019, and has a dividend yield of 3.6% as of November 20, 2023. How can we estimate the fair value of Aspial Lifestyle based on its dividend payments? In this article, we will use the Dividend Discount Model (DDM) to do so.
The Dividend Discount Model (DDM) is a valuation method that assumes that the value of a stock is equal to the present value of all the future dividends that the company will pay to its shareholders. The DDM requires two inputs: the expected dividend per share (DPS) and the discount rate. The discount rate is usually the cost of equity, which is the minimum return that investors require to invest in the company. The DDM can be expressed by the following formula:
Value Per Share = Expected Dividend Per Share / (Discount Rate – Perpetual Growth Rate)
The perpetual growth rate is the rate at which the dividends are expected to grow indefinitely. It is usually assumed to be equal to the long-term growth rate of the economy or the industry. A common proxy for the perpetual growth rate is the 5-year average of the 10-year government bond yield.
Applying the DDM to Aspial Lifestyle
To apply the DDM to Aspial Lifestyle, we need to estimate the expected DPS, the discount rate, and the perpetual growth rate. We will use the following assumptions:
- The expected DPS for the next year is S$0.005, which is the same as the last dividend paid by the company in June 2023.
- The discount rate is 9.1%, which is the cost of equity estimated by the Capital Asset Pricing Model (CAPM) using a risk-free rate of 1.9%, a market risk premium of 6%, and a beta of 1.2.
- The perpetual growth rate is 2%, which is the 5-year average of the 10-year Singapore government bond yield.
Using these inputs, we can calculate the value per share of Aspial Lifestyle as follows:
Value Per Share = S$0.005 / (0.091 – 0.02) = S$0.08
Comparing the Value Per Share with the Current Share Price
The value per share of S$0.08 suggests that Aspial Lifestyle is undervalued by the market, as the current share price is S$0.13 as of November 20, 2023. This implies a margin of safety of 38.5%, which means that the market is pricing in a lower growth rate or a higher discount rate than our assumptions. Alternatively, it could mean that our assumptions are too optimistic or that the company has other sources of value that are not captured by the DDM.
One way to check the validity of our valuation is to compare it with the valuations of Aspial Lifestyle’s peers in the specialty retail industry. According to Simply Wall St, the average value per share of Aspial Lifestyle’s peers is S$0.15, which is based on a variety of valuation methods, including the DDM. This suggests that Aspial Lifestyle is trading at a discount of 46.7% to its peers, which could indicate that the company is undervalued or that it has lower growth prospects or higher risks than its competitors.
Limitations of the DDM
The DDM is a simple and intuitive valuation method, but it also has some limitations that should be considered. Some of the limitations are:
- The DDM assumes that the company will pay dividends forever, which may not be realistic for some companies that may stop or reduce their dividend payments in the future.
- The DDM is sensitive to the inputs of the expected DPS, the discount rate, and the perpetual growth rate, which are difficult to estimate and may vary over time.
- The DDM does not account for the value of the company’s assets, liabilities, or growth opportunities that are not reflected in the dividend payments.
Therefore, the DDM should not be used as the sole basis for valuing a stock, but rather as one of the tools that can provide a rough estimate of the fair value. It is also advisable to use multiple valuation methods and compare the results to get a more comprehensive picture of the company’s value.