Dividend Discount Model

If a stock pays $2/year in dividends, that payment is expected to keep growing at 3% a year, and you want a 10% return, the Gordon Growth version of DDM values it at $2 ÷ (0.10 − 0.03) ≈ $29. It's like valuing a bond off its coupon, but for a growing dividend.

The Gordon Growth (constant-growth) version of DDM values a stock as next year's expected dividend divided by the required rate of return minus the assumed perpetual growth rate: D₁ ÷ (r − g). Because it discounts dividends specifically rather than total cash flow, it works best for mature, stable payers — utilities, banks, consumer staples — where the dividend reliably reflects cash returned to shareholders. It breaks down for companies that pay no dividend or grow it erratically, and it's highly sensitive to the (r − g) spread: as g approaches r, the value explodes, so small assumption changes swing the output dramatically. Multi-stage DDM variants let growth change across several phases (faster growth for some years, then a stable terminal rate) to soften that sensitivity.

Value = D₁ ÷ (r - g) where D₁=next dividend, r=required return, g=growth rate