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Formula, calculation and example

Dividend Discount Model (DDM)

The Dividend Discount Model estimates a stock's intrinsic value from the present value of expected future dividends. The constant-growth Gordon Growth Model is the simplest version and works best for mature companies with stable dividend policies.

DDM formula

P₀ = D₁ / (r − g)

In the Gordon Growth version, P₀ is intrinsic value today, D₁ is next year's expected dividend, r is the required rate of return and g is perpetual dividend growth. The required return must be higher than the growth rate for the formula to be meaningful.

Key inputs

Next dividend (D₁)
The dividend expected over the next year, not simply the last dividend already paid.
Required return (r)
The return investors demand for the stock's risk, often estimated with a cost-of-equity model.
Dividend growth (g)
A sustainable long-term growth assumption supported by earnings growth and the retention ratio.
Payout sustainability
Free cash flow, earnings stability and balance-sheet capacity supporting future distributions.

Gordon Growth DDM example

  1. 1Assume a company is expected to pay a $2.10 dividend over the next year.
  2. 2Use an 8% required rate of return and a 3% perpetual dividend growth rate.
  3. 3Subtract growth from the required return: 8% − 3% = 5%.
  4. 4Divide the $2.10 next dividend by 5%.

The constant-growth DDM estimates intrinsic value at $42.00 per share. At a $35 market price the modeled discount is about 17%, but the conclusion depends on the dividend remaining sustainable.

When DDM is useful

  • Established companies with consistent and sustainable dividend payments.
  • Income-focused investors evaluating the value of future distributions.
  • Comparing required return and long-term dividend growth assumptions.

Limitations to consider

  • The model is not suitable for companies that do not pay dividends.
  • Results become unstable when the assumed growth rate approaches the required return.
  • Dividend changes, buybacks and capital allocation decisions can reduce reliability.

How to calculate DDM

  1. 1Review dividend history, earnings, payout ratio and free cash flow coverage.
  2. 2Estimate the next annual dividend rather than using only the trailing payment.
  3. 3Choose a sustainable long-term dividend growth rate.
  4. 4Estimate the required rate of return for the stock's risk.
  5. 5Select a constant-growth or multi-stage DDM that matches the company.
  6. 6Discount expected dividends and compare intrinsic value with market price.
  7. 7Stress-test dividend cuts, slower growth and a higher required return.

How to interpret the result

A calculated value above the current stock price may indicate that the expected dividend stream is attractively priced. A lower value may indicate overvaluation. Because r minus g is the denominator, even small changes in either assumption can materially alter the result.

Compare related stock analysis models

Discounted Cash Flow

Value total business cash flow when dividends do not reflect the company's full earning power.

Relative Valuation

Compare dividend-based value with the multiples of similar listed companies.

Piotroski F-Score

Check whether profitability, leverage and cash-flow quality support the dividend.

Frequently asked questions

What is the Dividend Discount Model formula?

The Gordon Growth formula is P₀ = D₁ divided by r minus g, where D₁ is next year's dividend, r is required return and g is perpetual growth.

Which companies are suitable for DDM?

DDM is best suited to mature companies with stable earnings, predictable cash flows and a long record of regular dividend payments.

Can DDM value growth stocks?

Usually not well. Many growth companies reinvest cash instead of paying dividends, so a cash-flow-based or relative valuation model is often more appropriate.

What is the Gordon Growth Model?

The Gordon Growth Model is a constant-growth DDM that assumes dividends grow indefinitely at a stable rate below the required return.

What happens if dividend growth exceeds required return?

The constant-growth formula becomes invalid. Use a lower sustainable terminal growth rate or a multi-stage model with high growth only in the early years.

Learn the method in context

Go beyond the formula with worked explanations, assumptions and common mistakes in the Stock Insights Academy.

Read the related Academy guide

Apply DDM to a stock

Use Stock Insights to combine this model with additional valuation and financial health checks.

Analyze a stock