Discounted dividend model
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Discounted dividend model (DDM)
A formula to estimate the intrinsic value of a firm by figuring the present value of all expected future dividends.
Also found in: Medical, Encyclopedia.
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Proposed by Gordon (1959), the formula is known as the Constant Growth Discounted Dividend Model. It allows us to extract the stock's required rate of return (r) from a security traded at its intrinsic value as:
We use a discounted dividend model to value preferred shares, applying 3% payout ratio and 7% discount rate.
The literature on fundamental valuation includes studies from accounting that explore restatements of the discounted dividend model in terms of accounting information (see Feltham and Ohlson 1995; Penman 1996; Burgstahler and Dichev 1997) and finance papers that often start with or derive the discounted dividend model (see Gordon 1962; Rubinstein 1976; Barksy and DeLong 1993; Campbell and Kyle 1993; Donaldson and Kamstra 1996; Chiang, Davidson, and Okuney 1997; Bakshi and Chen 1998).
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