Enter the expected dividends per share, the cost of capital equity, and the dividend growth rate to determine the value of the stock using DDM.

DDM Formula

The following formula is used to calculate the value of a stock using DDM.

  • Where DDM is the stock value ($)
  • EDPS is the expected dividend per share ($)
  • CCE is the cost of capital equity (%)
  • DGR is the dividend growth rate (%)

What is DDM (Dividend Discount Model)?

The Dividend Discount Model (DDM) is a financial valuation tool used to estimate the intrinsic value of a stock based on its future dividend payments. It operates under the assumption that the present value of a stock is the sum of all its future dividends, discounted to its present value using a required rate of return.

The DDM is important because it provides investors with a practical framework for determining the fair value of a stock.

By analyzing the future stream of dividends, investors can assess whether a stock is overvalued or undervalued. This information is crucial for making informed investment decisions.

The DDM’s simplicity and intuitive nature make it a widely used model. It requires only two inputs: the expected future dividends and the required rate of return.

These inputs can be obtained from publicly available information, such as financial statements and market data. Consequently, the DDM can be applied to a wide range of stocks, making it a versatile tool for investors.

The DDM’s focus on dividends is significant because they represent a tangible return on investment. Dividends are the portion of a company’s earnings distributed to shareholders, providing a direct cash flow to investors.

By valuing a stock based on these cash flows, the DDM emphasizes the importance of dividends as a source of shareholder value.

Example Problem

How to calculate the stock value using DDM?

  1. First, determine the expected dividend per share for the current period.

    For this example, the dividend per share is expected to be $4.50.

  2. Next, determine the cost of capital.

    In this case, the cost of capital is found to be 8%.

  3. Next, determine the expected dividend growth rate.

    This dividend is expected to grow at 5% per year.

  4. Finally, calculate the value of the stock using the discount dividend model.

    Using the formula above, the stock value is found to be:

    DDM = EDPS / (CCE – DGR)
    DDM = 4.50 / (.08 – .05)
    DDM = $150.00