Dividend Discount Model (DDM)

Stocks as streams of dividends — the simplest version

Imagine you're considering buying a stock. Why is it worth anything at all? Because it's going to pay you cash in the future. That's it. The price you should pay today is the present value of all the cash you'll get from holding it.

The simplest model treats those future cash payments as dividends: a stream of payments the company makes to shareholders out of its profits. The model is called the Dividend Discount Model (DDM).

If a company pays dividend D next year and that dividend grows at rate g forever, and your required return is r, then by Gordon Growth (Track 2 lesson 6):

P = \frac{D}{r - g}

Same equation as Track 2's perpetuity-with-growth, just with D in the numerator instead of generic FCF. We're back at P = C/(r−g) shape — the thesis lesson's numerator-denominator play, now applied to a dividend stream.

Why DDM at all (and why it's limited)

DDM works cleanly for companies that pay reliable, growing dividends — utilities, mature consumer companies, REITs, dividend aristocrats. For those, dividends are a faithful proxy for the company's cash distribution, and the math is straightforward.

It breaks for companies that don't pay dividends (like most growth tech), companies that pay irregular dividends, or companies in early stages where future dividends are far away. In those cases, the right model is DCF on free cash flow, not DDM on dividends. Dividends are just one form of cash distribution; FCF is the broader concept.

An example with concrete numbers

Suppose Company K pays ₩500 in dividend next year. Investors expect that dividend to grow 4% per year, and the required return on equity is 9%. What's the stock worth?

P = \frac{500}{0.09 - 0.04} = \frac{500}{0.05} = 10, 000

So the stock is worth ₩10,000. If it's trading at ₩8,000, it might be undervalued; at ₩12,000, overvalued. (Assuming the inputs — D, g, r — are right, which is the whole game.)

What can change the price?

Three drivers, same as Track 1 lesson 3:

D goes up — company increases dividend. Numerator up, P up.
r goes down — interest rates fall, required return falls. Denominator down, P up.
g goes up — growth expectations rise. Denominator down (because we're subtracting a bigger number), P up.

Reverse for any to push P down. Same numerator-denominator play we keep coming back to. DDM is its dividend-flavored special case.

Multi-stage DDM (briefly)

Real companies often have non-constant growth: high growth for a few years, then slowdown to mature growth. Multi-stage DDM models this with explicit forecasts for the high-growth period followed by a Gordon Growth "terminal value" for everything after. Same logic, just more steps. Don't worry about the algebra; understand the picture.

The takeaway

DDM = P = D / (r − g). A dividend-flavored Gordon Growth. Best for companies with reliable dividends. Same three drivers as the thesis equation. Multi-stage variants handle non-constant growth. For non-dividend-payers, DCF on FCF is the right tool — next lesson.