The dividend discount model (DDM) is a valuation method used to estimate the intrinsic value of a company’s stock based on the present value of its future dividends. One of the most well-known variations is a specific formulation that assumes a constant growth rate for dividends in perpetuity. This model allows for a simplified calculation using readily available inputs such as the current dividend, the required rate of return (discount rate), and the expected dividend growth rate. For instance, if a company’s current annual dividend is $2, the required rate of return is 10%, and the expected constant growth rate is 5%, the model would calculate the intrinsic value as $42.
This particular DDM formulation offers investors a straightforward approach to valuing stocks with predictable dividend payouts. It provides a benchmark against which to compare current market prices, potentially identifying undervalued or overvalued opportunities. Developed and popularized by Myron J. Gordon, this approach remains a cornerstone of fundamental analysis. Its enduring relevance stems from its simplicity and its focus on dividends as a key driver of shareholder return, particularly for established, dividend-paying companies. However, its limitations, including the assumption of constant growth, necessitate careful consideration and often complementary valuation methods.