Dividend Discount Model (DDM)

A present value model that estimates the intrinsic value of an equity share based on the present value of its expected future dividends.

The fundamental dividend discount model which is impractical because it requires us to estimate every dividend in the future.

The Gordon Growth Model simplifies this process by assuming that dividends will grow in perpetuity at a single constant growth rate.  Such a model is therefore most appropriate for valuing stable and mature, non-cyclical, dividend-paying firms.

For dividend-paying firms with growth rate that is expected to change, some form of the multistage growth model should be employed. 

The 2-stage growth model assumes that the initial high growth rate will slow to a constant sustainable long-term growth rate.  This model is therefore more appropriate for a firm with high current growth rate that will drop to a stable rate in the future.

One variant of a multistage growth model assumes that the firm has three stages of dividend growth, not just two. These three stages can be categorised as growth, transition, and maturity. Such model would be appropriate for firms with an initial high growth rate, followed by a lower growth rate during a transitional period, followed by the constant growth rate in the long run.

See also: FCFE Model

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