Stock Valuation - DDM

Value a dividend-paying stock using the Gordon Growth Model.

Problem Scenario

A stock just paid a $3.00 dividend. Dividends grow at 4% per year. Required return is 10%.

Given Data

D0$3.00

Growth rate4%

Required return10%

Requirements

Find intrinsic value per share
Determine if the stock is over or undervalued at $55

Solution

Step 1:

D1 = D0 × (1+g) = 3.00 × 1.04 = $3.12.

Step 2:

P = D1 / (r - g) = 3.12 / (0.10 - 0.04) = 3.12 / 0.06.

Step 3:

P = $52.00.

Final Answer

Intrinsic value = $52.00. At $55, the stock is overvalued by $3.

Key Takeaways

✓Always use D1, not D0
✓Growth rate must be less than required return

Common Errors to Avoid

✗Using D0 instead of D1
✗Setting g equal to or greater than r

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FAQs

Common questions about this problem type

Use a multi-stage DDM: forecast dividends individually, then apply Gordon Growth for the stable phase.

D0 is the dividend just paid. D1 is the next expected dividend, which is D0 x (1+g). The Gordon Growth Model values future cash flows, so you must use the next dividend the investor will actually receive.