Canon's dividend valuation

Until recently, I've seen Canon's dividend as a nice, but not vital piece of the valuation puzzle. But in the last few years, Canon has raised its dividend to a point where the company can be valued on actual payments to shareholders rather than cash flows which might never reach investors. Here is a chart of dividend information for the last 10 years:

                2007    2006    2005    2004   2003   2002   2001   2000   1999   1998   1997  
Dividend        ¥150.00 ¥125.00 ¥100.00 ¥65.00 ¥50.00 ¥30.00 ¥25.00 ¥21.00 ¥17.00 ¥17.00 ¥17.00
Dividend growth 20.00%  25.00%  53.85%  30.00% 66.67% 20.00% 19.05% 23.53% 0.00%  0.00%  -
Expected growth 11.00%  11.75%  12.28%  13.14% 13.25% 10.49% 10.11% 9.18%  4.61%  8.13%  9.47%
DDM for 5 years ¥7,867  ¥6,813  ¥5,597  ¥3,800 ¥2,939 ¥1,533 ¥1,253 ¥1,003 ¥638   ¥769   ¥824
Price           ¥7,131  ¥7,050  ¥6,710  ¥5,560 ¥5,090 ¥4,580 ¥4,660 ¥4,250 ¥4,160 ¥2,320 ¥3,040

"Expected growth" is the mathematical maximum growth that can be sustained based on a Canon's financial information. It is composed of retained earnings rate multiplied by return on equity. Only earnings that are retained (about 75% of income) may be reinvested to fund future dividend growth and the return on equity over the next five years is likely to be about the same as it is this year (15% or so). Multiply those rates and you get a growth rate of about 11% a year. Notice that actual dividend growth has been somewhat better than that since 1999 in order to make up for some flat years in the late 1990s.

I discount that growth at 5% for the next 5 years. This rate seems appropriate for the low return on Japanese risk-free investment. At the end of 5 years, I assume Canon's dividend will grow at 2% compared to a discount rate of 5%. As you can see above, 2007 will be the first year in which the Dividend Discount Model values Canon higher than its market price. Since the dividend-only model is as conservative as you get in valuation, there's no particular reason to construct a more elaborate model when the value exceeds the current price. Converted to dollars, the DDM values Canon at about $64. Meanwhile, the Quicken model I've used in the past puts the value at $77. The current price is $58.59, so by either measure, Canon is still a good buy after doubling over the last 5 years.

Since this estimate is based on what Canon is already doing, I see at least two free options offered by the stock. First, SED TVs could add substantially to Canon's bottom line. Second, consumers in emerging markets such as China, India, Russia, Brazil, and Mexico may soon afford lower-end digital cameras and printers to replace traditional film cameras. Canon has pretty much eliminated the PC as a necessary part of the digital imagery work-flow and the upfront costs are within an order of magnitude of film costs. Over the long-term, digital pictures are vastly cheaper to process and far more convenient for most consumers than film, so I expect the switch-over will happen over the next five years or so. Kodak and Fujifilm sell billions of dollars of film equipment and services around the world and Canon has a shot at nearly all of that business now.