A:

A company's share price is theoretically determined by the summation of the company's expected future dividends as calculated by the Gordon growth model. The equation for the Gordon growth model, also known as the dividend discount model, is represented by the following:

Present value of stock = (dividend per share) / (discount rate - growth rate)

The equation above treats a stock's present value similarly to a perpetuity, because it is assumed the company's dividend payments are fixed and known throughout the life of the dividend payments. It is easy to see, however, that although a stock price is conceptually determined by its expected future dividends, many companies do not distribute dividends. Many market forces also contribute a company's stock price.

The stock market is driven by supply and demand, much like any market. When a stock is sold, a buyer and a seller exchange money for share ownership. The price for which the stock is purchased becomes the new market price. When a second share is sold, this price becomes the newest market price, etc.

The more demand for a stock, the higher it drives the price and vice versa. The more supply of a stock, the lower it drives the price and vice versa. So while in theory, a stock's IPO is at a price equal to the value of its expected future dividend payments, the stock's price fluctuates based on supply and demand.

RELATED FAQS
  1. How is perpetuity used in the Dividend Discount Model?

    Learn about how the concept of a stock perpetuity is used in the basic dividend discount model, which is also known as the ... Read Answer >>
  2. What kinds of companies are the best candidates for evaluation using the Gordon Growth ...

    Learn what the Gordon growth model is, how it's used to value a company and what candidates are best suited for evaluation ... Read Answer >>
  3. How can I use the Dividend Discount Model (DDM) effectively for a stock with fluctuating ...

    Find out how the dividend discount model is applied to stocks with irregular dividend payments and how firms with irregular ... Read Answer >>
  4. How do I find the information needed for input into the Dividend Discount Model (DDM)?

    Learn where analysts and investors can find the three pieces of necessary information that allow them to calculate the dividend ... Read Answer >>
  5. Can dividends be paid out monthly?

    Find out if stocks can pay dividends monthly, and learn about the types of companies most likely to do so and how monthly ... Read Answer >>
  6. What does the Dividend Discount Model (DDM) show an investor about a company?

    Discover the purpose of the dividend discount model, or DDM, of stock analysis and what it specifically aims to evaluate ... Read Answer >>
Related Articles
  1. Investing

    Digging Into The Dividend Discount Model

    The DDM is one of the most foundational of financial theories, but it's only as good as its assumptions.
  2. Investing

    Why Dividends Matter

    Seven words that are music to investors' ears? "The dividend check is in the mail."
  3. Investing

    Valuation Of A Preferred Stock

    Determining the value of a preferred stock is important for your portfolio. Learn how it's done.
  4. Investing

    How Dividends Affect Stock Prices

    Find out how dividends affect the price of the underlying stock, the role of market psychology and how to predict price changes after dividend declaration.
  5. Investing

    Due Diligence On Dividends

    Understanding dividends and how they work will help you become a more informed and successful investor.
  6. Investing

    The Top 5 Dividend Paying Oil Stocks for 2016

    Discover the top five dividend-paying oil companies for 2016 and what factors contribute to their ability to continue dividend payments.
  7. Investing

    The 3 Biggest Misconceptions of Dividend Stocks

    To find the best dividend stocks, focus on total return, not yield.
  8. Investing

    Dividend Yield For The Downturn

    High-dividend stocks make excellent bear market investments, but the payouts aren't a sure thing.
  9. Investing

    AAPL: Apple Dividend Analysis

    Apple's dividend has had healthy growth ever since its 2012 reinstatement, thanks to Apple's continuously rising revenue, earnings and operating cash flow.
RELATED TERMS
  1. Gordon Growth Model

    A model for determining the intrinsic value of a stock, based ...
  2. Dividend

    A distribution of a portion of a company's earnings, decided ...
  3. Stock Dividend

    A dividend payment made in the form of additional shares, rather ...
  4. Dividend Growth Rate

    The annualized percentage rate of growth that a particular stock's ...
  5. Dividend Rate

    The total expected dividend payments from an investment, fund ...
  6. Dividend Policy

    The policy a company uses to decide how much it will pay out ...
Hot Definitions
  1. Current Assets

    A balance sheet account that represents the value of all assets that can reasonably expected to be converted into cash within ...
  2. Tax Liability

    The total amount of tax that an entity is legally obligated to pay to an authority as the result of the occurrence of a taxable ...
  3. Preferred Stock

    A class of ownership in a corporation that has a higher claim on its assets and earnings than common stock. Preferred shares ...
  4. Net Profit Margin

    Net Margin is the ratio of net profits to revenues for a company or business segment - typically expressed as a percentage ...
  5. Gross Margin

    A company's total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. ...
  6. Current Ratio

    The current ratio is a liquidity ratio measuring a company's ability to pay short-term and long-term obligations, also known ...
Trading Center