The DDM Formula

The Dividend Discount Formula requires the following components:

• Annual Dividend Per Share — The amount each investor receives as compensation for investing in the company.
• Dividend Growth Rate — Represents the rate at which the dividend is increased from year to year. The dividend growth rate can undergo a stable or constant growth and it can also undergo a combination of different stages:
• A high, aggressive and unsustainable growth rate for a finite period of time.
• A slower and declining growth rate for a finite period of time.
• A stable growth rate for an indefinite period of time (perpetuity).
• Required Rate of Return — Also called “cost of equity”, is the minimum rate of return an investor requires to compensate him for the risk undertaken in investing in the stock. The Capital Asset Pricing Model (CAPM) is often used to determine the rate. The rate calculated should be higher than the dividend growth rate otherwise the stock will have a negative intrinsic value.

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