Dividend Discount Model

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The Dividend Discount Model is a way of valuing a company based on the theory that a stock is worth the discounted sum of all of its future dividend payments.^[1] In other words, it is used to evaluate stocks based on the net present value of the future dividends. ^[2]

Dividend discount model is a tool that produces a number based on the data provided. The equation can be written as

Stock Price = Div / (r - g)

This equation is also used to estimate cost of capital by solving for r

r = (Div / Stock price) + g

"g" is the assumed growth rate of dividend. From the first equation, one might notice that in the long run, the growth rate cannot exceed the cost of equity; r-g cannot be negative . In the short run if g>r, then usually a two stage DDM is used.