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Priya Natarajan, CFA, an analyst at Wexbridge Capital, covers Corvane Medical, a maker of diagnostic imaging software. Corvane paid a dividend of $1.50 per share for the year just ended. Its dividend growth is currently 14% a year, well above the industry, but Natarajan expects competition to erode that advantage. She models the growth rate as falling in a straight line over the next 8 years to a long-term rate of 5%, which it then keeps indefinitely. Corvane's required return on equity is 10%.

Natarajan values Corvane with the H-model. She also wants to know how much of her estimate comes from the period of above-normal growth, as opposed to the value the stock would have if dividends grew at the long-term rate from today.

To test whether Corvane can fund growth internally, Natarajan estimates its sustainable growth rate from the company's return on equity and earnings retention. She decomposes return on equity into its components using the data in Exhibit 1, which she believes reflect Corvane's long-run profitability, efficiency and capital structure.

Natarajan's clients are individual investors who hold small minority positions. Corvane has paid a dividend every year for twelve years; its payout ratio has stayed close to 40% of earnings throughout, so dividends have moved in line with profits. The company's free cash flow has been negative in three of the last five years because of heavy capital spending on new data centers.

Exhibit 1. Corvane Medical: selected data

Net profit margin: 8.0%

Asset turnover: 1.25 times

Financial leverage (assets / equity): 1.60 times

Dividend payout ratio: 40%

Current dividend growth rate: 14%, declining linearly over 8 years

Long-term dividend growth rate: 5%

Required return on equity: 10%

Priya Natarajan, CFA, an analyst at Wexbridge Capital, covers Corvane Medical, a maker of diagnostic imaging software. Corvane paid a dividend of $1.50 per share for the year just ended. Its dividend growth is currently 14% a year, well above the industry, but Natarajan expects competition to erode that advantage. She models the growth rate as falling in a straight line over the next 8 years to a long-term rate of 5%, which it then keeps indefinitely. Corvane's required return on equity is 10%.

Natarajan values Corvane with the H-model. She also wants to know how much of her estimate comes from the period of above-normal growth, as opposed to the value the stock would have if dividends grew at the long-term rate from today.

To test whether Corvane can fund growth internally, Natarajan estimates its sustainable growth rate from the company's return on equity and earnings retention. She decomposes return on equity into its components using the data in Exhibit 1, which she believes reflect Corvane's long-run profitability, efficiency and capital structure.

Natarajan's clients are individual investors who hold small minority positions. Corvane has paid a dividend every year for twelve years; its payout ratio has stayed close to 40% of earnings throughout, so dividends have moved in line with profits. The company's free cash flow has been negative in three of the last five years because of heavy capital spending on new data centers.

Exhibit 1. Corvane Medical: selected data

Net profit margin: 8.0%

Asset turnover: 1.25 times

Financial leverage (assets / equity): 1.60 times

Dividend payout ratio: 40%

Current dividend growth rate: 14%, declining linearly over 8 years

Long-term dividend growth rate: 5%

Required return on equity: 10%

Priya Natarajan, CFA, an analyst at Wexbridge Capital, covers Corvane Medical, a maker of diagnostic imaging software. Corvane paid a dividend of $1.50 per share for the year just ended. Its dividend growth is currently 14% a year, well above the industry, but Natarajan expects competition to erode that advantage. She models the growth rate as falling in a straight line over the next 8 years to a long-term rate of 5%, which it then keeps indefinitely. Corvane's required return on equity is 10%.

Natarajan values Corvane with the H-model. She also wants to know how much of her estimate comes from the period of above-normal growth, as opposed to the value the stock would have if dividends grew at the long-term rate from today.

To test whether Corvane can fund growth internally, Natarajan estimates its sustainable growth rate from the company's return on equity and earnings retention. She decomposes return on equity into its components using the data in Exhibit 1, which she believes reflect Corvane's long-run profitability, efficiency and capital structure.

Natarajan's clients are individual investors who hold small minority positions. Corvane has paid a dividend every year for twelve years; its payout ratio has stayed close to 40% of earnings throughout, so dividends have moved in line with profits. The company's free cash flow has been negative in three of the last five years because of heavy capital spending on new data centers.

Exhibit 1. Corvane Medical: selected data

Net profit margin: 8.0%

Asset turnover: 1.25 times

Financial leverage (assets / equity): 1.60 times

Dividend payout ratio: 40%

Current dividend growth rate: 14%, declining linearly over 8 years

Long-term dividend growth rate: 5%

Required return on equity: 10%

Priya Natarajan, CFA, an analyst at Wexbridge Capital, covers Corvane Medical, a maker of diagnostic imaging software. Corvane paid a dividend of $1.50 per share for the year just ended. Its dividend growth is currently 14% a year, well above the industry, but Natarajan expects competition to erode that advantage. She models the growth rate as falling in a straight line over the next 8 years to a long-term rate of 5%, which it then keeps indefinitely. Corvane's required return on equity is 10%.

Natarajan values Corvane with the H-model. She also wants to know how much of her estimate comes from the period of above-normal growth, as opposed to the value the stock would have if dividends grew at the long-term rate from today.

To test whether Corvane can fund growth internally, Natarajan estimates its sustainable growth rate from the company's return on equity and earnings retention. She decomposes return on equity into its components using the data in Exhibit 1, which she believes reflect Corvane's long-run profitability, efficiency and capital structure.

Natarajan's clients are individual investors who hold small minority positions. Corvane has paid a dividend every year for twelve years; its payout ratio has stayed close to 40% of earnings throughout, so dividends have moved in line with profits. The company's free cash flow has been negative in three of the last five years because of heavy capital spending on new data centers.

Exhibit 1. Corvane Medical: selected data

Net profit margin: 8.0%

Asset turnover: 1.25 times

Financial leverage (assets / equity): 1.60 times

Dividend payout ratio: 40%

Current dividend growth rate: 14%, declining linearly over 8 years

Long-term dividend growth rate: 5%

Required return on equity: 10%