How it works
The dividend discount model values a stock as the present value of its dividend stream. The Gordon growth version assumes dividends grow forever at a constant rate: fair value equals next year's dividend divided by the gap between your required return and the growth rate. The model is unforgiving about assumptions — the denominator must be positive (required return above growth) or the math breaks, and small input changes swing the output wildly: raising growth from 4% to 5% at a 9% required return lifts fair value by 20%. The engine's message is the sensitivity: a stock trading at $80 with a DDM fair value of $72 is telling you either the market expects faster dividend growth than you assumed, or it demands a lower return than yours. Use the model for stable, mature dividend payers — utilities, consumer staples, REITs — where constant growth is plausible; for high-growth companies it is noise, because dividend growth is not stable.
Formula
Fair value = D1 / (required return - growth rate)
Tips
- This model fits mature, stable dividend payers only — growth stocks fail its assumptions.
- Raise the required return (discount) to reflect risk: higher discount, lower fair value.
- Compare fair value against market price, then ask what growth rate the market is implying.
- Pair with the Dividend Reinvestment (DRIP) calculator for the compounding side of the same stock.
Frequently asked questions
- What is the Gordon growth model?
- A dividend valuation formula: fair value equals next year's dividend divided by (required return minus dividend growth). It assumes dividends grow at a constant rate forever — hence it is only valid for mature, stable dividend payers, and the required return must exceed the growth rate.
- Why is the model so sensitive to growth?
- Because the denominator is a small difference between two larger numbers. At a 9% required return, growth of 5% gives a denominator of 4%; growth of 6% gives 3% — a 25% smaller denominator, so a 33% higher fair value. The formula punishes fuzzy assumptions, which is its most useful trait.
- What does a market price above DDM fair value mean?
- Either the market expects faster dividend growth than your input, or it requires a lower return than yours (you are more risk-averse), or the market is overpaying. The model's value is forcing that question — check which input would justify the price.
- Does the model work for companies that don't pay dividends?
- No — it requires a dividend stream. For non-payers, use the DCF valuation calculator, which values free cash flow instead of dividends, or the P/E ratio calculator for a market multiple view.