What is the Dividend Discount Model Formula?
The Dividend Discount Model (DDM) is a means of valuing a stock price in which the current fair price is assumed to equal to the sum of all the company's future dividend discounted back to their present value. In other words, the stock is worth all of the future cash flows discounted by an appropriate risk-adjusted rate. Ideally, if the present value under DDM turns out to be higher than the current trading price, the stock is undervalued and indicates a signal for a buy decision.
Dividend Discount Model
Generally speaking, companies or business sells goods or provide services to generate profits. After all the allocations, the remaining profits will be used to distribute dividends to its stockholders. This valuation scheme uses the time value of money principle, which means your one hundred dollars today will not worth as much next year. DDM was developed on the assumption that the stock's intrinsic value is the present value of the future cash flows generated by the stocks.
The Formula for Dividend Discount Model
Summarized below are variations of dividend discount model formulas:
Gordon Growth Model
One of the most commonly used variation technique is the Gordon Growth Model (GGM). It is based on the premise that the stream of future dividends will infinitely grow at a constant rate. It is mathematically expressed as:
Where:
• V0 = the current fair value of a stock
• D1 = the dividend payment in one period from now
• r = the estimated cost of equity capital
• g = the constant growth rate of the company's dividends for an infinite time
One-Period Dividend Discount Model
This model is used when an investor wants to ascertain the stock's intrinsic value that he will sell in one-period from now on. It is used much less frequently compared to GGM. Here's the equation.
Where:
• V0 = the current fair value of a stock
• D1 = the dividend payment in one-period from now
• P1 = the stock price in one-period from now
• r = the estimated cost of equity capital
Multi-Period Dividend Discount Model
This is an extension of the one-period dividend discount model wherein an investor aims to hold his stocks for multiple periods. This variation requires to forecast dividend payments for different periods. It uses below formula:
Where can I get these models?
Since the dividend discount model has different formulas for different variations, it might be a bit challenging to perform these calculations on your own. Thus, there's a bunch of templates available for the dividend discount model formula, which you could efficiently work on. These templates are made in Excel sheets that allow you to change values and get the desired result in few clicks.
Conclusion: Dividend Discount Model Formula helps make an investment decision
The dividend discount model is a logical attempt to value the company's stocks. Investing in a stock based on the value of future dividends would be a perfect system. However, several variables are affecting the stock market; thus, it is not always reliable. Whatever the variation was used, there could still be a challenge. Investors should at least attempt to approximate the value of stocks before making any investment decision.
Dividend Discount Model
Generally speaking, companies or business sells goods or provide services to generate profits. After all the allocations, the remaining profits will be used to distribute dividends to its stockholders. This valuation scheme uses the time value of money principle, which means your one hundred dollars today will not worth as much next year. DDM was developed on the assumption that the stock's intrinsic value is the present value of the future cash flows generated by the stocks.
The Formula for Dividend Discount Model
Summarized below are variations of dividend discount model formulas:
Gordon Growth Model
One of the most commonly used variation technique is the Gordon Growth Model (GGM). It is based on the premise that the stream of future dividends will infinitely grow at a constant rate. It is mathematically expressed as:
• V0 = the current fair value of a stock
• D1 = the dividend payment in one period from now
• r = the estimated cost of equity capital
• g = the constant growth rate of the company's dividends for an infinite time
One-Period Dividend Discount Model
This model is used when an investor wants to ascertain the stock's intrinsic value that he will sell in one-period from now on. It is used much less frequently compared to GGM. Here's the equation.
• V0 = the current fair value of a stock
• D1 = the dividend payment in one-period from now
• P1 = the stock price in one-period from now
• r = the estimated cost of equity capital
Multi-Period Dividend Discount Model
This is an extension of the one-period dividend discount model wherein an investor aims to hold his stocks for multiple periods. This variation requires to forecast dividend payments for different periods. It uses below formula:
Where can I get these models?
Since the dividend discount model has different formulas for different variations, it might be a bit challenging to perform these calculations on your own. Thus, there's a bunch of templates available for the dividend discount model formula, which you could efficiently work on. These templates are made in Excel sheets that allow you to change values and get the desired result in few clicks.
Conclusion: Dividend Discount Model Formula helps make an investment decision
The dividend discount model is a logical attempt to value the company's stocks. Investing in a stock based on the value of future dividends would be a perfect system. However, several variables are affecting the stock market; thus, it is not always reliable. Whatever the variation was used, there could still be a challenge. Investors should at least attempt to approximate the value of stocks before making any investment decision.
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