What is the Dividend Discount Model?

•The dividend discount model (DDM) is a procedure for valuing the price of a stock by using the predicted dividends and discounting them back to the present value. If the value obtained from the DDM is higher than what the shares are currently trading at, then the stock is undervalued.




DDM Example

•Company ABC just paid a $3.00 dividend and its dividend is expected to grow at a rate of 5% indefinitely. ABC has a beta 1.2, return on the market is 12% and the risk free rate is 4%. What would the intrinsic value of ABC stock be?




DDM Example

•First we would figure out the discount rate (required rate of return) by using the CAPM.


CAPM

Required return = rf + beta (rm – rf)

.04 + 1.2(.12 - .04) = .136

Constant Growth Dividend Model

$3.00 (1.05) = $36.63
  .136 - .05



Last modified: Tuesday, August 14, 2018, 8:50 AM