Valuation
Dividend discount model
Also called DDM or Gordon growth model
Valuing a share as the present value of all the dividends it will ever pay.
How it works
The simplest version assumes dividends grow at a constant rate for ever, which gives a compact formula requiring only next year’s dividend, a growth rate and a required return.
It works best for stable, mature, reliably dividend-paying companies — utilities, consumer staples, some financials.
Where it misleads people
The model breaks completely when the growth rate approaches the required return, producing an infinite value. It is also useless for companies that pay no dividend, which is most of the fastest-growing ones.
Formula
Value = next year’s dividend ÷ (required return − growth rate)Related terms
- DividendA cash payment a company makes to its shareholders out of its profits.
- Discount rateThe rate used to convert future money into what it is worth today.
- Discounted cash flowValuing a business by estimating its future cash flows and converting them to today’s money.
- Payout ratioThe share of earnings a company pays out as dividends rather than reinvesting.
More in Valuation
Educational reference only. Nothing here is investment advice or a recommendation to buy or sell anything, and tax treatment depends on your own circumstances and the country you are in.