Dividend discount model: formula, calculator and examples
The dividend discount model asks a simple question: if a stock's only value is the dividends it will pay you, what's it worth today? The answer is useful, and very sensitive to your assumptions.
The formula (Gordon growth model)
value per share = D₁ ÷ (r − g) - D₁ = next year's dividend = this year's dividend × (1 + g)
- r = your required rate of return
- g = the rate the dividend grows forever
Example: a company pays $2.00 a year, you expect 5% growth, and you want a 9% return. D₁ = $2.10, so value = $2.10 ÷ (0.09 − 0.05) = $52.50. If the stock trades at $48, the model says it's slightly cheap under your assumptions.
Try it
Estimated value per share
$52.50
Next year's dividend of $2.10 ÷ (9.0% − 5.0%).
- Next year's dividend (D₁)
- $2.10
- Implied return at today's price
- 9.38%
- Value vs price
- +9.4%
- Forward yield at price
- 4.38%
Turn it around: what return is the market implying?
Rearranging the formula is often more useful than valuing the stock:
expected return = D₁ ÷ price + g = forward dividend yield + dividend growth A stock with a 3% forward yield whose dividend grows 6% a year implies roughly a 9% annual return, if that growth holds and the valuation stays put. This is a quick sanity check on any dividend stock: is yield plus realistic growth enough to justify owning it?
Why small changes swing the answer
Same $2.00 dividend, different assumptions:
| Growth ↓ / Required return → | 8% | 9% | 10% |
|---|---|---|---|
| 4% | $52.00 | $41.60 | $34.67 |
| 5% | $70.00 | $52.50 | $42.00 |
| 6% | $106.00 | $70.67 | $53.00 |
Moving growth by one point and required return by one point in opposite directions can shift the value by more than half. That's not a flaw in the math; it's a reminder that the model is only as good as your inputs. Use it to compare scenarios, not to produce a precise price target.
Multi-stage models
Few companies grow their dividend at one steady rate forever. A two-stage model lets the dividend grow faster for a few years (say 8% for five years), then settle at a lower long-term rate (say 4%). You discount each of the early dividends individually, then apply the Gordon formula from the point growth settles, and discount that value back to today. It's more realistic, and still very sensitive to the long-term rate.
When the model works, and when it doesn't
| Works reasonably for | Doesn't work for |
|---|---|
| Mature companies with steady, growing dividends (utilities, consumer staples, many banks) | Companies that pay no or tiny dividends |
| Comparing two dividend stocks on the same assumptions | Companies whose dividend growth is temporarily very high |
| Checking what return a price implies | Businesses with unpredictable profits or likely dividend cuts |
Before trusting the growth input, check the payout ratio: dividends can't outgrow earnings for long. And to see what a growth rate means for your actual income over time, run it through the dividend calculator.
The model and examples are educational. A model value is not a recommendation to buy or sell any security.
Frequently asked questions
What is the dividend discount model formula?
The constant-growth (Gordon growth) version is: value = D₁ ÷ (r − g), where D₁ is next year's dividend, r is your required rate of return and g is the dividend's long-term growth rate. D₁ equals the current dividend × (1 + g).
What is the difference between the dividend discount model and the dividend growth model?
The Gordon growth model, sometimes called the dividend growth model, is the simplest form of the dividend discount model. It assumes dividends grow at one constant rate forever. Multi-stage models allow faster growth for a few years before settling to a lower long-term rate.
Why does the model give crazy numbers sometimes?
Because value depends on the gap between r and g. When the growth rate gets close to the required return, the denominator shrinks toward zero and the value explodes. If g is equal to or higher than r, the formula doesn't work at all.
Can I use the dividend discount model for growth stocks?
Not really. It only suits companies that pay a meaningful, steadily growing dividend. For companies that pay little or no dividend, cash-flow or earnings-based valuation methods are more appropriate.
Sources and further reading
Keep reading
What is a dividend? A plain-English guide
How dividends work, the different types, how much they pay and how they are taxed.
Read the guide →
Dividend investing for beginners: how to start
Six steps, a realistic 25-year example and the mistakes that cost beginners most.
Read the guide →
Dividend reinvestment (DRIP): how it works and when it pays off
A 30-year worked example, DRIP in a falling market, cost basis, and when to turn it off.
Read the guide →