The Dividend Discount Model (DDM)

The idea

Just like DCF, but instead of the free cash the company generates, we count the money that reaches the shareholder: dividends. Every expected future dividend is discounted to today, and they are added up.

If we assume the dividend grows at a steady rate every year forever, that sum collapses into a simple formula: value = next year's expected dividend ÷ (required return − growth rate). The required return is the return you want for the risk, like the discount rate in DCF. This constant-growth version is called the Gordon model, and it is the one this lesson explains. DDM as a family also includes multi-stage models that assume different growth in different periods.

A worked example

An invented company is expected to pay EGP 1.50 per share next year. You want an 18% return and assume the dividend will grow 8% a year.

At 8% growth: 1.50 ÷ 0.10 = EGP 15. Assume 12% instead: 1.50 ÷ 0.06 = EGP 25. The gap is large because the denominator shrank. The closer growth gets to the required return, the faster the estimate balloons.

Which companies does it suit?

The simple Gordon model suits companies that pay out a fairly steady share of their profits every year, with a regular dividend history. For a company that pays nothing, pays irregularly, or keeps its profits to expand, the model will understate its value or simply not apply.

Also remember that a dividend is a decision the company takes each year, not a fixed obligation. Past dividends do not guarantee future ones.

Check yourself

Summary

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