I hear you. But Nautilus' ROE is about 20% right now, isn't it? The earnings yield is only 6% or 7%, agreed, but the return for the stock -- if they do retain earnings and successfully grow -- is somewhere in the middle ground between 20% and 6% for all but the shortest-term investors.
For those investors who have a risk-free opportunity paying say 10%, I gotta agree, those guys would probably be best off receiving the whole dollar in dividends.
W/r/t risk, I'm not using the risk-free rate because I think there's no risk. I've actually assigned the "growth" scenario a mere 33% probability by averaging it at equal weight with two no-growth scenarios. So I'm assuming it's pretty high risk. Using the risk-free rate only to avoid double counting the risk.
If Nautilus needs funding beyond its own earnings, then I agree that debt seems much better deal than equity given the undervalued (imo) stock. At $50 per share I'd reverse that and sell shares to pay off debt.
The business cost of capital isn't a function of share price behavior unless they do in fact get their capital by issuing shares. For example, a private company has no share price yet it still has a well-defined cost of capital.
After unpleasant experiences with NLS and another investment or two, I think that almost all that can be said about growth is that it's "probably positive" or "probably negative"; thus DCF models are an instance of "garbage in, garbage out". ROE, averaged over the last several years if you believe the company has recently suffered a temporary setback, is of course useful, but only in relation to what you have to pay for equity. Damodoran's well-known book on asset valuation suggests using (P/B)/ROE as a stock selection criterion.
I hear you. I agree that NLS is taking the right path reinvesting earnings at the higher ROE. And since you probablility weighted the scenarios, I see your point regarding your assumed discount rate.
I don't have time to do the math, but it would be interesting to average your mid and high scenarios, and then discount using the equity discount I offered up before ( I think it was around 10.5% if remembering correctly).