Multistage Dividend Discount Model

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DEFINITION

An equity valuation model that builds on the Gordon growth model by applying varying growth rates to the calculation. Under the multistage model, changing growth rates are applied to different time periods. Various versions of the multistage model exist including the two-stage, H, and three-stage models.

INVESTOPEDIA EXPLAINS

The two-stage model has an unstable initial growth rate, and can be either positive or negative. This initial phase lasts for a specified time and is followed by stable growth which lasts forever. The problem with this model is that the growth rate from the initial phase is assumed to change to the stable growth rate overnight.

The H-model has an initial growth rate that is already high, which then declines to a stable growth rate over time. This model assumes that a company's dividend payout ratio and cost of equity remains constant, which is its biggest downfall.

Finally the three-stage model has an initial phase of stable high growth that lasts for a certain period. In the second phase the growth rate declines linearly until it reaches the a final stable growth rate. This model improves upon both previous models and can be applied to nearly all firms.


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