How the Dividend Discount Model Calculator works
The Dividend Discount Model (DDM) values a share of stock as the present value of the dividends it is expected to pay in the future. This calculator uses the most common version — the Gordon Growth Model, named after economist Myron Gordon — which assumes a company's dividend grows at a single constant rate forever. That assumption turns an infinite sum of discounted future dividends into one simple, closed-form equation.
The formula
For a current annual dividend D₀, an expected constant annual growth rate g, and an investor's required rate of return r, the model first grows the dividend one year forward, then capitalizes it:
D₁ = D₀ × (1 + g)
P = D₁ / (r − g)
Here P is the estimated intrinsic (fair) value per share. The formula only produces a finite, positive value when the required return r is greater than the growth rate g — if growth were allowed to equal or exceed the discount rate, the sum of discounted dividends would never converge, since a perpetually growing stream discounted at or below its own growth rate does not shrink over time.
Worked example
Suppose a stock currently pays a $2.00 annual dividend, is expected to grow that dividend by 5% a year indefinitely, and an investor requires a 9% annual return to hold the stock. Next year's dividend is D₁ = $2.00 × 1.05 = $2.10. The fair value is then P = $2.10 / (0.09 − 0.05) = $2.10 / 0.04 = $52.50 per share. If the stock currently trades at $40, the model suggests it may be undervalued by about 31% relative to that fair-value estimate — a signal to investigate further, not a guarantee of future price movement.
What moves the fair value most
- The spread between r and g: because both sit in the denominator's difference, a small change in either has an outsized effect. Narrowing the 9% − 5% spread in the example to 3% (r = 8%) raises the fair value to $70; widening it to 6% (r = 11%) drops it to $35.
- The growth rate assumption: a higher assumed g raises both the numerator (D₁) and shrinks the denominator, compounding the effect on fair value. Small, seemingly reasonable bumps to a long-run growth assumption can move the valuation dramatically.
- The current dividend: D₀ scales the result linearly — doubling the starting dividend doubles the fair value, holding r and g constant.
Assumptions and limitations of the Gordon Growth Model
The model assumes a single, constant growth rate forever, which fits mature, stable dividend payers better than young or cyclical companies with irregular or fast-changing payouts. It also assumes the company keeps paying dividends indefinitely, so it is not meaningful for stocks that pay no dividend. Because the output is highly sensitive to the r − g spread, small errors in estimating either the required return or the long-run growth rate can produce large swings in the calculated fair value. This calculator performs the standard arithmetic only; it does not know a company's actual payout policy, business risk, or growth prospects, and its output should be treated as one input among several, not a standalone buy or sell signal.