Dividend Discount Model Calculator
Calculate the true value of a stock using our Dividend Discount Model (DDM) Calculator. Estimate future dividends, discount rate, and dividend growth rate to determine if a stock is undervalued or overvalued. Make informed investment decisions using this valuation approach.
Formulas
The formulas we use in our DDM Calculator are listed below:
Expected Growth Rate = ( 1 – Dividend Payout Ratio ) × Return on Equity
Expected Dividends Next Year = Dividends per Share × (1 + Expected Growth Rate)
Cost of Equity = Risk-Free Rate + Beta × Market Risk Premium
Fair Value = Expected Dividends Next Year / (Cost of Equity – Expected Growth Rate)
You might also want to use our Capital Asset Pricing Model (CAPM) Calculator
According to the DDM model, the current value of a share is equal to the summation of the net present value (NPV) of all future dividend payments. It can take a variety of forms, which vary according to the assumptions that are applied in relation to anticipated dividend growth.
However, in its most basic form, the Gordon Growth Model, the value of a stock is based on the application of the assumption that dividend growth will be stable. The following formula can be employed to determine the fair value of shares according to the Gordon Growth model:
Fair Value = Expected Dividends Next Year / (Cost of Equity – Expected Growth Rate)
Let's look at an example.
Let's say we have a stock that will pay an anticipated dividend per share of $5 in the next period at the cost of equity of 12% and an ongoing future growth rate of 3% in perpetuity. This stock would be valued as follows:
Value = $5 / (.12 − .03) = $55.56
As such, according to the DDM, the fair value of the share is $55.56. If the shares were to trade at any point above $55.56, they would be overvalued. If they were to trade below $55.56, they would be undervalued.
What is Dividend Discount Model Calculator
A Dividend Discount Model (DDM) calculator is a tool used to estimate the intrinsic value of a stock based on its expected future dividends. The DDM is a valuation method commonly used by investors to determine the fair value of a dividend-paying stock.
Here's how a typical DDM calculator works:
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Dividend Growth Rate: You input the expected annual growth rate of dividends for the stock. This represents the anticipated percentage increase in dividends over time. It can be based on historical dividend growth patterns, industry trends, or company forecasts.
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Discount Rate: You input the required rate of return or discount rate for the stock. This is the minimum return that an investor expects to earn when investing in the stock. It takes into account factors such as the riskiness of the investment, prevailing interest rates, and the investor's opportunity cost.
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Dividend Payment: You input the most recent dividend payment made by the company. This can be obtained from financial statements or dividend history.
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DDM Calculation: The DDM calculator uses the formula:
Stock Value = Dividend Payment / (Discount Rate - Dividend Growth Rate)
It divides the dividend payment by the difference between the discount rate and the dividend growth rate to calculate the intrinsic value of the stock.
The DDM assumes that the value of a stock is equal to the present value of its expected future dividends. It implies that an investor's primary source of return comes from the dividends received rather than capital gains.
It's important to note that the DDM has certain limitations and assumptions. It assumes that dividends grow at a constant rate indefinitely, which may not hold true in reality. The model also does not account for other factors such as changes in market conditions, company performance, or external events that can impact the stock's value.
Moreover, the DDM is most suitable for mature companies with a stable dividend payment history. For companies that do not pay dividends or have inconsistent dividend patterns, alternative valuation methods should be considered.
The DDM calculator provides an estimate of the intrinsic value of a stock based on expected dividends and the investor's required rate of return. It can assist investors in evaluating whether a stock is undervalued or overvalued and making informed investment decisions.
However, it's important to conduct thorough research, consider other financial metrics, and assess the specific circumstances of the company before making investment decisions solely based on the DDM calculation.
Dividend Discount Model Calculator Example
Certainly! Here's an example of using the Dividend Discount Model (DDM) to calculate the intrinsic value of a stock using a table:
Assume the following information for a company:
| Year | Dividend per Share (DPS) | Discount Rate (r) |
|---|---|---|
| 1 | $2 | 10% |
| 2 | $2.50 | 10% |
| 3 | $3 | 10% |
| 4 | $3.50 | 10% |
| 5 | $4 | 10% |
To calculate the intrinsic value of the stock, you can use the Dividend Discount Model (DDM) formula:
Intrinsic Value = (DPS1 / (1+r)^1) + (DPS2 / (1+r)^2) + ... + (DPSn / (1+r)^n)
Using the given dividends and discount rate, we can calculate the intrinsic value of the stock by substituting the values into the formula:
Intrinsic Value = ($2 / (1+0.10)^1) + ($2.50 / (1+0.10)^2) + ($3 / (1+0.10)^3) + ($3.50 / (1+0.10)^4) + ($4 / (1+0.10)^5)
After evaluating the expression, the intrinsic value of the stock would be approximately $13.93.
The Dividend Discount Model (DDM) is a valuation method used to estimate the intrinsic value of a stock based on its future dividends. The model assumes that the value of a stock is equal to the present value of its expected future dividends, discounted by a required rate of return or discount rate. By calculating the intrinsic value using the DDM, investors can compare it to the current market price of the stock to determine if it is overvalued, undervalued, or fairly valued.
