Dividend discount model
The dividend discount model (DDM) values a share as the present value of all its expected future dividends; its constant-growth form, the Gordon growth model, prices the share as next year's dividend divided by the required return minus.
FrameworkDividend discount model
What it is
See it move
Castellana Bank's current dividend of €2.00 is expected to grow 4% a year, giving D₁ = €2.08. Investors require a 10% return, so the Gordon growth model divides €2.08 by the 6% gap between that return and the growth rate, valuing the share at €34.67. Trading at €30, the share looks undervalued against this estimate.
The formula
Variables
- intrinsic value (current share price) (€)
- expected dividend in the next period (€)
- required rate of return on equity (decimal)
- constant perpetual dividend growth rate (decimal)
The Gordon growth model applies only when r > g. For a firm with near-term non-constant growth, discount each near-term dividend individually, then apply this formula as a terminal value at the point growth stabilises.