Dividend Discount Model Calculator

The Gordon growth model values a stock from its growing dividends.

How the Math Works

The Dividend Discount Model (DDM), specifically the Gordon Growth Model, calculates a stock's intrinsic value by discounting its expected future dividends to their present value. The formula P = D₁ ÷ (r − g) requires three inputs: D₁ (the expected dividend next year), r (the required rate of return), and g (the constant growth rate of dividends). The model assumes dividends grow at a steady rate indefinitely, and the denominator (r − g) ensures the growth rate is lower than the required return to avoid unrealistic valuations. This formula reflects the core principle of time value of money, where future cash flows are worth less than present ones due to opportunity costs and risk.

Practical Applications

To use this calculator, first estimate the next year's dividend (D₁) by adjusting the most recent dividend for expected growth (D₀ × (1 + g)). Next, determine the required rate of return (r) based on your risk tolerance and market conditions, and input your projected long-term dividend growth rate (g). For example, if a stock pays $2 in dividends (D₀) with a 5% growth rate, D₁ becomes $2.10. If your required return is 10%, the stock's fair value is $2.10 ÷ (0.10 - 0.05) = $42. Compare this result to the current stock price to assess whether it's undervalued (buy) or overvalued (sell).

Day-to-Day Use

This tool empowers everyday investors to make informed decisions about dividend-paying stocks without needing advanced financial expertise. By estimating a stock's true value, you can identify opportunities to buy undervalued companies or trim overvalued holdings, optimizing your portfolio for long-term growth and income. It's particularly useful for retirement planning, as it helps build a reliable stream of dividend income by focusing on stable, growing companies. Additionally, it provides a framework for evaluating the sustainability of dividend policies and comparing investment options based on their growth potential relative to risk.

Worked example

$2 ÷ (8% − 3%) → $40.

FAQ