Dividend Discount Model - DDM

AAA

DEFINITION of 'Dividend Discount Model - DDM'

A procedure for valuing the price of a stock by using predicted dividends and discounting them back to present value. The idea is that if the value obtained from the DDM is higher than what the shares are currently trading at, then the stock is undervalued.

 

Dividend Discount Model (DDM)

INVESTOPEDIA EXPLAINS 'Dividend Discount Model - DDM'

This procedure has many variations, and it doesn't work for companies that don't pay out dividends. For example one variation is the supernormal dividend growth model which takes into account a period of high growth followed by a lower, constant growth period. The principal behind the model is the net present value of the cash flows. To get a growth number, one option is to take the return on equity (ROE) and multiply it by the retention ratio (which is 1-the payout ratio).

VIDEO

Loading the player...
RELATED TERMS
  1. Dividend

    A distribution of a portion of a company's earnings, decided ...
  2. Discount Rate

    The interest rate charged to commercial banks and other depository ...
  3. Dividend Aristocrat

    A company that has continuously increased the amount of dividends ...
  4. Overvalued

    A stock with a current price that is not justified by its earnings ...
  5. Undervalued

    A financial security or other type of investment that is selling ...
  6. Valuation

    The process of determining the current worth of an asset or company. ...
RELATED FAQS
  1. How does the required rate of return affect the price of a stock, in terms of the ...

    First, a quick review: the required rate of return is defined as the return, expressed as a percentage, that an investor ... Read Full Answer >>
Related Articles
  1. Investing

    Using the Dividend Discount Model

    The dividend discount model is a way of applying net present value analysis to estimate the future dividends a stock will pay. Those dividends are then discounted back to their present value. ...
  2. Markets

    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.
  3. Investing Basics

    How And Why Do Companies Pay Dividends?

    If a company decides to pay dividends, it will choose one of three approaches: residual, stability or hybrid policies. Which a company chooses can determine how profitable its dividend payments ...
  4. Fundamental Analysis

    The History Of The Modern Portfolio

    Learn how the writings of John Burr Williams and Harry Markowitz led to the creation of the investment portfolio.
  5. Markets

    Valuing A Stock With Supernormal Dividend Growth Rates

    If these calculations are off, it could drastically change the value of the shares.
  6. Markets

    Company Clone Cost Reveals True Value

    Find out how calculating a reproduction cost for a company can beat out the dividend discount model.
  7. Investing Basics

    How Dividends Work For Investors

    Find out how a company can put its profits directly into your hands.
  8. Options & Futures

    Trade Covered Calls On High Dividend Paying Stocks

    We explain the risks, rewards, timing, and profit and loss considerations for covered calls with dividend stocks.
  9. Mutual Funds & ETFs

    Should the YYY ETF Be on Your Radar?

    Why you should, or shouldn't, invest in YYY.
  10. Mutual Funds & ETFs

    How To Build A Bond Ladder?

    Bond laddering is a strategy used when building a portfolio: an investor can spread out interest rate risk and create a stream of cash flows for income.

You May Also Like

Hot Definitions
  1. Interest Rate Risk

    The risk that an investment's value will change due to a change in the absolute level of interest rates, in the spread between ...
  2. Income Effect

    In the context of economic theory, the income effect is the change in an individual's or economy's income and how that change ...
  3. Price-To-Sales Ratio - PSR

    A valuation ratio that compares a company’s stock price to its revenues. The price-to-sales ratio is an indicator of the ...
  4. Hurdle Rate

    The minimum rate of return on a project or investment required by a manager or investor. In order to compensate for risk, ...
  5. Market Value

    The price an asset would fetch in the marketplace. Market value is also commonly used to refer to the market capitalization ...
  6. Preference Shares

    Company stock with dividends that are paid to shareholders before common stock dividends are paid out. In the event of a ...
Trading Center