The formulas
- D_t = D_0 x (1 + g1)^t for t = 1 to N
- Terminal value at N = D_N x (1 + g2) / (r - g2)
- Value = sum of D_t / (1 + r)^t + terminal value / (1 + r)^N
- N = 0 gives Gordon growth: D_0 x (1 + g2) / (r - g2)
How it works
The dividend discount model values a share as the present value of the dividends it will pay. The Gordon growth form assumes one constant growth rate forever. The two-stage form allows a period of faster growth before settling at a long-term rate.
The long-term rate must be below the required return and should not exceed long-run nominal economic growth. The terminal value usually carries most of the value, as the last row shows, so the answer is most sensitive to the gap between r and g2.
Illustrative figures only. Check the result against your firm's methodology before relying on it.
Common questions
Why next year dividend in Gordon growth?
The model values dividends from year 1 onward. D_0 was just paid and belongs to the seller.
What required return do I use?
A cost of equity, often from CAPM.
Does it work for companies with no dividend?
Not directly. Use free cash flow to equity in place of dividends.
Formulas on this page are the standard definitions.
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