CNA Financial Corp (NYSE: CNA) currently pays a dividend yield of 2.6% which is above the Financials sector median of 2.1%. While this makes the total return potential for Cna Financial look attractive, investors may change their mind when analyzing the company’s future dividends. In this article, I calculate Cna Financial’s fair value by forecasting its dividend distributions and discounting them back to today’s value.
Valuation Methodologies Are Not Made Equally
The Dividend Discount Model (DDM) estimates the value of a company’s stock price based on the theory that its worth is equal to the sum of the present value of its future dividend payments to shareholders.
But how do we know if it’s appropriate to use a dividend discount analysis when estimating the fair value of CNA Financial? Many analysts find it difficult when trying to figure out the correct valuation methodology for a given company or are biased towards one specific approach. This is often a mistake which can negatively impact investment decisions and result in trading losses or missed opportunities. No two companies are the same and every business consists of unique characteristics that may require you to adjust your analysis.
Understanding leverage trends is the first step when determining what valuation analyses are relevant for a given company. When a company’s leverage doesn’t fluctuate or is expected to remain stable over time, then an equity valuation model (e.g. equity DCF, DDM) will be the most appropriate valuation technique. The reason for this is because when leverage is stable, interest expense on debt can typically be projected with much more reliability.
How do we check if a company’s leverage has been fluctuating or is expected to do so? This isn’t always straightforward but checking recent debt ratio trends can be a good indicator. CNA Financial’s debt to equity ratio has been relatively stable over last few years ranging from 21.8% to 23.7%. This suggests that an equity valuation model is a suitable technique when valuing the company’s shares. Now does it make sense to use a dividend discount model knowing that an equity valuation technique is an appropriate methodology?
