Dividend Discount Model (DDM)

  • If James Brown is the “Godfather of Soul”, then the dividend discount model could be considered the “Godfather of Equity Valuation”. Many of the approaches used today can trace their roots to DDM.
  • The basic thesis of the DDM is that the value of a common stock to an investor is the present value of expected future dividend payments.
  • DDM Single Holding Period

V0 = (Div1 + P1) /(1 + rce)

  • V0 = present value
  • Div1 = dividend expected over the next year
  • P1 = share price expected when stock is sold in one year
  • Note: for simplicity sake, this assumes the single holding period is equal to one year.

If the analyst believes that his/her inputs into the single period DDM are accurate, then he/she will compare the calculated value to the market price in order to determine the investment recommendation.

  • DDM Multiple Holding Periods

V0 = (Div1 / (1 + rce)) + (Div2 / (1 + rce)2) + ... + (Divn + Pn) /(1 + rce)n

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