What is the Total Payout Method?

Hey there! Terry Williams here, your friendly neighborhood data analyst and tech geek dropping by with an in-depth look at the total payout method. I know valuation methods aren‘t the most scintillating topic, but stick with me! I promise this will be an engaging dive into an important concept in corporate finance.

As an avid gamer and streamer, I‘m always interested in analyzing systems and figuring out their underlying mechanics. So let‘s unlock the core workings of the total payout model so you can level up your financial knowledge!

The total payout model is a valuation approach that determines a company‘s worth based on expected future payouts to shareholders, including dividends and stock buybacks.

In a nutshell, it works by:

• Estimating the company‘s future dividend payments and stock repurchases

• Discounting these future payouts back to the present to account for the time value of money

• Summing these discounted payouts to calculate total firm value

The key advantage of this method is it considers all cash flows returned to shareholders, not just dividends like some other models. This provides a more complete picture of shareholder returns.

A Real-World Example

Let‘s imagine a fictional company called Runeterra Inc. As a fellow League of Legends fan, I think you‘ll appreciate the reference!

Runeterra currently pays a $1 dividend each year and expects this to continue for the next 5 years. The company also plans to repurchase $5 million of its shares over the next 5 years.

For valuation purposes, we‘ll assume:

• 100 million shares outstanding currently
• A 12% required annual return for shareholders

Applying the total payout model with these inputs gives us:

Year 1

• Dividends = $1 * 100 million shares = $100 million

• PV of Dividends = $100 million / (1.12)^1 = $89.3 million

• Share Repurchases = $5 million / 5 years = $1 million

• PV of Repurchases = $1 million / (1.12)^1 = $0.893 million

• Total Payout Value = $89.3 million + $0.893 million = $90.2 million

Year 2

• PV of Dividends = $100 million / (1.12)^2 = $79.7 million
• PV of Repurchases = $1 million / (1.12)^2 = $0.797 million
• Total Payout Value = $80.5 million

Year 3

• PV of Dividends = $71.1 million
• PV of Repurchases = $0.712 million
• Total Payout Value = $71.8 million

Year 4

• PV of Dividends = $63.4 million
• PV of Repurchases = $0.636 million
• Total Payout Value = $64 million

Year 5

• PV of Dividends = $56.7 million
• PV of Repurchases = $0.568 million
• Total Payout Value = $57.3 million

Total Firm Value = $90.2 million + $80.5 million + $71.8 million + $64 million + $57.3 million = $363.8 million

And there you have it! By discounting and summing all expected future payouts, we arrive at a valuation of approximately $364 million for Runeterra Inc.

Key Components of the Model

Now that you‘ve seen the total payout method in action, let‘s dive deeper into its key ingredients:

1. Expected Future Dividends

Projected dividend payments per share for the explicit forecast period – often 3-5 years, and sometimes as long as 10 years. Requires analyzing past dividend trends and management guidance.

2. Expected Share Repurchases

Estimate of total cash used by the company for stock buybacks over the forecast period. Based on past repurchase activity and stated buyback plans.

3. Required Rate of Return

Also called the discount rate – reflects shareholders‘ expected return on their investment. Often calculated using the Capital Asset Pricing Model (CAPM).

4. Number of Shares Outstanding

Used to forecast total dividend amounts from per-share estimates. Must be adjusted over time for share repurchases.

Getting reliable estimates for these inputs is critical to an accurate valuation. It involves synthesizing many sources of information on the company‘s finances and strategy.

As a data whiz, this kind of analytical challenge gets me fired up!

Comparing Total Payout to Other Models

The total payout model has some notable differences from other popular equity valuation methods:

Model	Cash Flows Considered	Values
Dividend Discount	Dividends only	Per share
Discounted Cash Flow	All, to all capital providers	Total firm
Total Payout	Dividends & buybacks	Total equity

Among dividend-based models, total payout is the most comprehensive since it incorporates repurchases. This avoids undervaluing companies that return significant cash through buybacks but pay low dividends.

Overall, think of total payout as a "hybrid" model – it strikes a balance between pure dividend and full DCF models.

Advantages and Disadvantages

As with any valuation technique, the total payout model has some pros and cons:

Advantages

• Accounts for all cash returned to shareholders, not just dividends
• Can value companies that emphasize buybacks over dividends
• Allows modeling different payout scenarios for sensitivity analysis

Disadvantages

• Difficult to estimate future dividends and buybacks
• Hard to determine accurate required rate of return
• Doesn‘t consider reinvested earnings and capital gains

No single model is perfect or paints the full picture. The total payout approach makes reasonable simplifying assumptions, but still provides insight into a company‘s intrinsic value.

Valuation models rely heavily on actual data. So let‘s explore some real-world statistics on dividends, buybacks, and payout ratios for US companies:

• Dividends per share for S&P 500 companies:

  Year	Dividends Per Share
  2020	$58.28
  2019	$57.77
  2018	$51.69
  2017	$45.57
  2016	$43.79

  Data source: S&P Dow Jones Indices

• Total spent on share repurchases by S&P 500 companies:

  Year	Buybacks ($Billions)
  2021	$882
  2020	$520
  2019	$728
  2018	$806
  2017	$519

  Data source: S&P Dow Jones Indices

• Average dividend payout ratio of S&P 500 companies:

  • 2010-2019 average: 41%
  • 1999-2019 average: 39%

  Data source: S&P Global

These figures provide the raw material for projecting future payouts in valuations. The data shows significant fluctuations year to year, highlighting the need for informed estimates.

As a numbers guy, I geek out on stats like this! But the key takeaway is real-world data is crucial for applying models properly.

Well, that wraps up my deep dive into the intricacies and nuances of the total payout model! I know I covered a lot of ground, but I hope this provided a comprehensive yet engaging look at how this valuation method works.

Here are some key points to remember:

• Values firms based on dividends + buybacks
• Discounts future payouts to present value
• More comprehensive than dividend-only models
• Requires accurate projections of future payouts

Let me know if you have any other questions! I could talk valuations all day. Understanding these models takes some work, but being able to analyze a company‘s intrinsic value is an invaluable skill for any investor.

Thanks for sticking with me on this journey into the riveting world of valuation methods! Never be afraid to level up your financial knowledge. Your future money-savvy self will thank you.