I understand PVGO= (D1 or D0)/(Kc-G). However, Im trying to understand the intuitive meaning of PVGO and how it relates to the intrinsic value of a stock. For example, if given the intrinsic value of a stock (V0) with growth. And the intrinsic value of the same stock WITHOUT growth, does PVGO= Vo(with growth)-Vo(without growth)? So essentially all PVGO is really showcasing is the economic value added of a corporation pursuing Capital projects as oppose to paying out dividends?
You’re correct. Assume that the business did not reinvest anything. Then, the value of the stock would be the value of an ordinary perpetuity (i.e. EPS/r) - in this case we capitalize earnings because with a 100% payout, EPS = Dividends per share.
If the firm has profitable investment opportunities (i.e. they can earn more on reinvested capital than investors can), they create value by reinvesting some portion of earnings back into the firm for positive NPV projects.
In this case, reinvestment will result in growth in earnings (and Dividends). So, instead of the value being EPS/r it becomes D/(r-g).
The key is that PVGO > 0 if the firm has positive NPV opportunities and retains some earnings.
Thank you, your explanation really helped clarify things. Had to double check my sanity.
You’re welcome. Glad it helped.