The Daily Technical #106: Which types of intangible assets are amortized?

Good morning. Welcome to the 106th edition of The Daily Technical. You’re here for one reason so let’s dive in.

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OVERVIEW OF YESTERDAY’S QUESTION
What are the major drawbacks of the dividend discount model (DDM)?

Forward-looking valuation methods each have their shortcomings, and the DDM is no exception, given its sensitivity to assumptions such as the dividend payout ratio, dividend growth rate, and required rate of return.

But some additional drawbacks that help explain why DDM is used less often include:

The DDM cannot be used on high-growth companies as the denominator would turn negative since the growth rate would exceed the expected return rate.

The DDM is more suitable for large, mature companies with a consistent track record of paying out dividends, but even then, it can be very challenging to forecast out the growth rate of dividends paid.

Most companies don't pay out any dividends, especially as share buybacks have become common.

The DDM neglects buybacks, an increasingly important source of returns for shareholders.

If the dividend payout amounts reflected true financial performance, then the output would be similar to the traditional DCF. However, poorly run companies can still issue large dividends, distorting valuations.

Common Mistakes

1. Neglecting the importance of assumption sensitivity in DDM, like dividend growth rate and required return rate. Always emphasize how small variances in these inputs can lead to vastly different valuations.

2. Forgetting to mention that DDM fails for high-growth companies where growth rates surpass return rates. Highlight the impossibility of applying DDM when the model's assumptions cause the equation to break down.

3. Failing to address that DDM isn't applicable for companies not paying dividends. Make sure to note that buybacks, a prevalent method of returning capital to shareholders, are ignored by DDM.

TL;DR

• DDM is based on assumptions: dividend payout ratio, growth rate, required return rate. This adds sensitivity.

• Not suitable for high-growth firms; growth rate often exceeds expected returns, causing a negative denominator.

• Best for large, mature companies, yet difficult to forecast precise dividend growth.

• Omits share buybacks, ignoring a major shareholder return mechanism.

• Misses the mark when firms mismanage funds or pay dividends not reflecting financial health, unlike DCF.

DEAL TALK
Constellation Energy’s $26.6B Acquisition of Calpine Bets Big on AI-Driven Power Demand

Constellation Energy is acquiring Calpine in a $26.6B cash-and-stock deal, assuming $12.7B in debt. The transaction cements Constellation’s dominance as the largest competitive power producer in the U.S., expanding its portfolio with natural gas, nuclear, and geothermal assets.

Learn more about how to walk through this deal in today’s edition of The Deal Talk.

TODAY’S QUESTION
Which types of intangible assets are amortized?

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