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
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.