What is the 'Dividend Discount Model  DDM'
The dividend discount model (DDM) is a procedure for valuing a stock's price by discounting predicted dividends to the present value. If the value obtained from the DDM is higher than the current trading price of shares, then the stock is undervalued.
BREAKING DOWN 'Dividend Discount Model  DDM'
The dividend discount model is based on the idea that the intrinsic value of a stock can be estimated by the expected value of the cash flows it will generate in the future. The driving principle behind the model is the net present value (NPV) of the cash flows, which draws from the concept of the time value of money (TVM).
The DDM is derived from the formula for the present value of a perpetuity. Its variables include the dividend per share, the discount rate (also the required rate of return or cost of equity) and the expected rate of dividend growth. The model, therefore, does not work for companies that don't pay out dividends. While not accurate for most companies, the simplest iteration of the dividend discount model assumes zero growth in the dividend, in which case the value of the stock is the value of the dividend divided by the required rate of return.
The required rate of return can vary due to investor discretion. Meanwhile, the dividend growth rate can be estimated by multiplying the return on equity (ROE) by the retention ratio (the latter being the opposite of the payout ratio).
Dividend Discount Model Variations and Calculation
The DDM has many variations that differ in complexity. The supernormal dividend growth model, for example, takes into account a period of high growth followed by a lower, constant growth period. For more on valuing a stock using this model, see: Valuing a Stock With Supernormal Growth Rates.
The most common and straightforward calculation of a DDM is known as the Gordon growth model (GGM), which assumes a stable dividend growth rate and was named in the 1960s after American economist Myron J. Gordon. To find the price of a dividendpaying stock, the GGM takes into account three variables:
 D_{1} = the estimated value of next year's dividend
 r = the company's cost of equity capital
 g = the constant growth rate for dividends, in perpetuity
Using these variable, the equation for the GGM is:
 Price per Share = D_{1} / (r  g)
Examples of the DDM With Stable Growth
Assume Company X paid a dividend of $1.80 per share this year. The company expects dividends to grow in perpetuity at 5% per year, and the company's cost of equity capital is 7%. The $1.80 divided is the dividend for this year and needs to be adjusted by the growth rate to find D_{1}, the estimated dividend for next year. This calculation is: D_{1} = D_{0} x (1 + g) = $1.80 x (1 + 5%) = $1.89. Next, using the GGM, Company X's price per share is found to be D(1) / (r  g) = $1.89 / ( 7%  5%) = $94.50.
Now, take for example the annual cash dividends paid out by Walmart Inc. between January 2014 and January 2018: $1.92, $1.96, $2.00, $2.04 and $2.08, in chronological order. Walmart's dividend has increased by $0.04 each year, which equals average growth of about 2%. Assume an investor has a required rate of return of 5%. Using an estimated dividend of $2.12 at the beginning of 2019, the investor would use the dividend discount model to calculate a pershare value of $2.12/(.05  .02) = $70.67.
Shortcomings of the DDM
While the GGM method of DDM is widely used, it has two wellknown shortcomings. The model assumes a constant dividend growth rate in perpetuity. This assumption is generally safe for very mature companies, but newer companies have fluctuating dividend growth rates in their beginning years.
The second flaw of this DDM is that the output is very sensitive to the inputs. For example, in the Company X example above, if the dividend growth rate is lowered 10% to 4.5%, the resulting stock price is $75.24 (over a 20% reduction in the $94.50 price).

Dividend
A dividend is a distribution of a portion of a company's earnings, ... 
Capital Dividend
A capital dividend is a type of payment a firm makes to its investors ... 
Multistage Dividend Discount Model
The multistage dividend discount model is an equity valuation ... 
Accumulated Dividend
An accumulated dividend is a dividend on a share of cumulative ... 
Illegal Dividend
An illegal dividend is a dividend declared by a corporation that ... 
Incremental Dividend
An incremental dividend is a series of regular increases to a ...

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. 
Investing
Valuing A Stock With Supernormal Dividend Growth Rates
If these calculations are off, it could drastically change the value of the shares. 
Investing
How Dividends Affect Stock Prices
Find out how dividends affect the underlying stock's price, the role of market psychology, and how to predict price changes after dividend declarations. 
Investing
Valuation Of A Preferred Stock
Determining the value of a preferred stock is important for your portfolio. Learn how it's done. 
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. 
Investing
Is Dividend Investing a Good Strategy?
Understanding dividends and how they generate steady income for shareholders will help you become a more informed and successful investor. 
Investing
WMT: WalMart Dividend Analysis
WalMart raised its dividend for the 43rd consecutive year, despite losing over 25% of its market value in 2015, and its dividend remains healthy in 2016. 
Investing
Put Dividends to Work in Your Portfolio
Find out how a company can put its profits directly into your hands. 
Investing
The Top 5 Dividend Paying Software Stocks for 2016 (MSFT, INFY)
Find out which five dividendpaying stocks in the software sector can bring the best yields and growth potential to your portfolio. 
Investing
The Power Of Dividend Growth
Dividends may not seem exciting, but they can certainly be lucrative. Learn more here!

What is the difference between yield and dividend?
Learn how to differentiate between dividend yield and dividend return, and see why dividend yield is the more popular rate ... Read Answer >> 
How does the dividend discount method (DDM) work?
Learn about the dividend discount model and when it can most appropriately be used to measure the value of a stock by fundamental ... Read Answer >> 
What are the drawbacks of using the Dividend Discount Model (DDM) to value a stock?
Understand how the dividend discount model works, and learn some of the inherent flaws in the model that make it suspect ... Read Answer >>