Lesson 36 - Advanced Accounting Course

Lesson 36: Dividend Discount Models and Market Valuation

💡 What is Market Valuation?

Market valuation means figuring out how much a company is worth today based on future expectations.
One way to do this is by looking at dividends — the payments companies give to shareholders.

📈 Investors want to know: “If I invest in this company today, what will I get back in the future?”

That’s where the Dividend Discount Model (DDM) comes in!

🧮 What is the Dividend Discount Model (DDM)?

The DDM is a valuation method used to estimate the intrinsic value of a company’s stock based on the theory that:

📌 A stock is worth the present value of all its future dividends.

✅ When to Use DDM?

DDM works best for companies that:

• 📦 Pay regular and predictable dividends
  
  

• 💼 Are stable and mature (e.g., banks, utilities)
  
  

• ❌ Not great for startups or high-growth firms with no dividends yet
  
  

🔣 Basic DDM Formula (No Growth)

If a company pays the same dividend every year:

Where:

• D = Annual dividend
  
  

• r = Required rate of return (cost of equity)
  
  

🧾 Example:

• Company pays $2 per share every year
  
  

• Required return is 8% (0.08)

So, the stock is worth $25 per share based on future dividends. 

📈 DDM with Constant Growth (Gordon Growth Model)

Most companies try to grow their dividends every year.

Where:

• D₁ = Dividend next year
  
  

• r = Required rate of return
  
  

• g = Dividend growth rate
  
  

🧾 Example:

• Next year’s dividend (D₁) = $3
  
  

• Expected growth (g) = 4%
  
  

• Required return (r) = 10%

So, the stock is worth $50 per share using DDM with growth.

🧠 What Affects DDM Valuation?

📊 Summary Table: Types of DDM Models 

🎯 Why Use DDM?

• ✅ Simple and clear if dividends are stable
  
  

• 📈 Helps determine if a stock is undervalued or overvalued
  
  

• 💰 Focuses on real cash returns to shareholders
  
  

But remember: ❗ DDM is only as good as your assumptions about growth and required return.

📘 Recap