Dividend Discount ModelDDM
The dividend discount model values a stock as the present value of all its future dividends. Its simplest form, the Gordon Growth Model, says value = next year's dividend ÷ (required return − dividend growth rate).
If a share is worth what it pays you, then its value should be the sum of all future dividends, discounted back to today. That is the idea behind the dividend discount model, one of the oldest valuation tools. It works best for steady dividend payers like utilities and mature companies. This entry explains the formula, a worked example and its blind spots.
- Category
- Fundamentals and Macroeconomics
- Reading time
- 3 min
- Also called
- Gordon Growth Model, DDM, Dividend valuation model
- Updated
The DDM in plain words
The DDM assumes a stock's fair price equals the sum of all its future dividends discounted to present value.1
It rests on the idea that intrinsic value reflects the present value of all future cash flows, with dividends as the cash paid to shareholders.1
Discounted cash flow analysis uses the same principle with a firm's free cash flows instead of dividends.2
How to use the Gordon Growth Model, step by step
Current dividend
D₀, the latest annual dividend. See Dividend.
Growth rate
g, a long-run sustainable rate.
Next dividend
D₁ = D₀ × (1 + g).
Required return
r, often from CAPM. See Capital Asset Pricing Model.
Value
D₁ ÷ (r − g).
Compare with price
Is the stock under- or overvalued? See Margin of Safety.
Worked examples
Example 1 — Gordon Growth valuation
$41.60Current dividend $2.00, growth 4%, required return 9%.
| Next dividend | $2.00 × 1.04 = $2.08 |
| Value | $2.08 ÷ (9% − 4%) = $41.60 |
The model turns expected dividends into a fair value with few inputs.1
Example 2 — Sensitivity to growth
Highly sensitiveSame inputs, but growth is 5% instead of 4%.
| Next dividend | $2.00 × 1.05 = $2.10 |
| Value | $2.10 ÷ 4% = $52.50 |
| Change | +26% from 1 point of growth |
Small changes in hard-to-forecast inputs swing the result a lot.1
Example 3 — Model breaks
Use a multi-stage modelA company grows dividends 10% while the required return is 9%.
| r − g | 9% − 10% = −1% |
| Result | Meaningless (negative value) |
The simple model only works when long-run growth is below the required return. See Discounted Cash Flow.
DDM vs DCF
| Aspect | DDM | DCF |
|---|---|---|
| Cash flow used | Dividends | Free cash flow |
| Best for | Steady dividend payers | Most companies |
| Inputs | Few | Many |
| See also | Dividend yield | Discounted Cash Flow |
Where the DDM is used
Utilities and REITs
Stable, high payouts.
Mature blue chips
Long dividend histories. See Dividend Aristocrats.
Banks and insurers
Where cash flows are hard to define.
Sanity checks
Cross-checking other valuations.
Advantages and disadvantages
Advantages
- Simple and transparent.
- Grounded in cash paid to shareholders.
- Few inputs required.
Disadvantages
- Useless for non-dividend stocks.
- Extremely sensitive to growth and required return.
- Assumes constant growth forever in its simple form.
Going deeper
Read as far as you need. Each level builds on the one before it.
Why discount
Beginner
A dollar received in the future is worth less than a dollar today, so future dividends are discounted. See Present and Future Value.
Hard-to-forecast assumptions
Intermediate
The model is easy to compute but depends on assumptions that can't be forecast easily.1
Multi-stage models
Advanced
For fast growers, analysts use a high-growth stage followed by a stable stage, valuing each separately — the same idea as a terminal value in a DCF. See Discounted Cash Flow.
Common mistakes
Growth above required return
The formula breaks.
Using it on non-payers
No dividends, no model.
Overconfident inputs
Test a range of values.
Mixing D₀ and D₁
The formula uses next year's dividend.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- The DDM values a stock by its future dividends.
- Gordon Growth: value = D₁ ÷ (r − g).
- It suits stable dividend payers.
- Results are very sensitive to inputs.
- Growth must be below the required return.
Frequently asked questions
Who uses the DDM?
What growth rate should I use?
Is the DDM accurate?
Further learning
- Discounted Cash Flow
The broader valuation method.
- Capital Asset Pricing Model
Estimating the required return.
- Dividend Yield
The current income view.
- Margin of Safety
Buying below estimated value.
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- Corporate Finance Institute. Dividend Discount Model (opens in a new tab) Checked .
- Corporate Finance Institute. Discounted Cash Flow (DCF) Formula (opens in a new tab) Checked .
Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.