Dividend models are used to estimate the value of a company’s stock based on its expected dividend payments. Two commonly used dividend models are the Dividend Discount Model (DDM) and the Gordon Growth Model (GGM).
Dividend Discount Model (DDM):
The DDM values a stock by discounting its expected future dividend payments to their present value.
It assumes that the intrinsic value of a stock is the sum of all its expected future dividends.
The model considers factors such as the dividend growth rate and the required rate of return.
Gordon Growth Model (GGM):
The GGM is a variation of the DDM that assumes a constant dividend growth rate.
It calculates the stock value by dividing the expected dividend by the difference between the required rate of return and the dividend growth rate.
The GGM is suitable when the company’s dividends are expected to grow at a stable rate indefinitely.
These models are not the preferred way of valuation since dividends are merely a distribution of profit. They do not reflect future profitability. If a company is declaring dividends out of capital, Dividend Models will result in a misleading valuation
