Part II: Dividend Discount Model

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Cliff Ang

Senior Vice President, Compass Lexecon

Single-Stage Dividend Discount Model

There are two types of stocks firms issue: preferred stocks and common stocks

Many preferred and common stocks pay dividends

Dividends are typically the "cash flows" that investors receive from holding stocks
We can then discount this stream of dividends to value the stock

Constant Dividend Stream

$ V = div_{t+1} / k $

Suppose $div_{t+1}$ = $ \$50 $ and $k$ = 6.25%.

div <- 50

k <- 0.0625

div / k

Dividend with Constant Growth

$ V = div_{t+1} / (k - g) $

Suppose $div_{t+1}$ = $ \$50 $, $k$ = 6.25%, and $g$ = 2%.

div <- 50

k <- 0.0625

g <- 0.02

div / (k - g)

1176.471

You can still use a DDM even for firms that do not currently pay dividends
Firms with high growth may not pay dividends now, but one can reasonably expect the firm's growth to slow down and begin paying dividends at some point in the future

Use a 2-stage Model
- 1st stage: No dividends for T years
- 2nd stage: Expect firm to pay dividends beginning Year T + 1

Mathematically:

$$ V = 0 + (div_{T+1} / (k - g)) * (1 / (1 + k)^{T}) $$

Year	1	2	3	4	5	6	7	...
Dividends	0	0	0	0	0	$50	$51	...

div6 <- 50

g <- 0.02

k <- 0.0625

0 + (div6 / (k - g)) * (1 / (1 + k)^6)

817.7253

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