The Dividends-Based Valuation Approach.
Explain the theory behind the dividends-based valuation approach. Why are dividends value-relevant to common equity shareholders?
The dividend-based approach is the approach where the firm's dividends are used to value the firm and its common equity per share.
The dividend-based approach is used when the firms pay dividends that are persistent with the profitability of the company. In other words, when the payout ratios remain stable. Additionally, the cost of capital and growth rate should not be volatile. Otherwise, a stable firm value cannot be estimated.
Dividend based approach is used when the shareholder wants to know about the wealth distribution of the company. It is generally for the shareholders that are non-controlling in nature.
The common equity shareholders are the people who receive these dividends. Since the dividend-based approach is the indicator of wealth distribution, the shareholders can judge the company's ability to distribute from what it earns.