Stock Price Calculator (Dividend Discount Model)
Use this calculator to estimate the intrinsic value of a stock using the Gordon Growth Model, a form of the Dividend Discount Model (DDM).
Calculated Intrinsic Stock Price:
Understanding How to Calculate Stock Price with the Dividend Discount Model (DDM)
Estimating the intrinsic value of a stock is a fundamental aspect of investing. While market prices are determined by supply and demand, an investor often seeks to understand a company's true worth to make informed decisions. One popular method for valuing dividend-paying stocks is the Dividend Discount Model (DDM), particularly the Gordon Growth Model.
What is the Dividend Discount Model (DDM)?
The Dividend Discount Model (DDM) is a quantitative method used for predicting the price of a company's stock based on the theory that its present-day price is worth the sum of all of its future dividend payments, discounted back to their present value. In simpler terms, if a company pays dividends, its stock value is derived from the income stream those dividends represent.
The Gordon Growth Model
The Gordon Growth Model (GGM) is a specific and widely used version of the DDM. It assumes that dividends grow at a constant rate indefinitely. The formula for the Gordon Growth Model is:
Stock Price = D1 / (r - g)
- D1: The expected dividend per share next year. This is not the current year's dividend, but the dividend expected in the upcoming year.
- r: The investor's required rate of return (or cost of equity). This is the minimum return an investor expects to receive for taking on the risk of investing in the stock.
- g: The constant growth rate in dividends, expected to continue indefinitely.
How the Calculator Works
Our calculator uses the Gordon Growth Model to help you estimate a stock's intrinsic value. You provide three key inputs:
- Expected Dividend Per Share Next Year (D1): This is the dividend you anticipate the company will pay out per share in the next 12 months. If the current dividend is known, you can estimate D1 by applying the growth rate (e.g., Current Dividend * (1 + g)).
- Required Rate of Return (r): This represents your personal hurdle rate for investing. It should reflect the riskiness of the investment and your alternative investment opportunities. It's often estimated using models like the Capital Asset Pricing Model (CAPM) or simply set based on your desired return.
- Constant Dividend Growth Rate (g): This is the rate at which you expect the company's dividends to grow each year, consistently into the future. This can be estimated from historical dividend growth, analyst forecasts, or the company's sustainable growth rate (ROE * Retention Ratio).
The calculator then applies the Gordon Growth Model formula to provide an estimated intrinsic stock price.
Important Considerations and Limitations
- Constant Growth Assumption: The biggest limitation is the assumption of a constant dividend growth rate forever. In reality, growth rates fluctuate.
- Required Rate of Return > Growth Rate: The model mathematically requires that the required rate of return (r) be greater than the dividend growth rate (g). If r ≤ g, the formula yields an infinite or negative stock price, which is illogical. This implies that the model is not suitable for companies with very high or unsustainable growth rates.
- Dividend-Paying Companies Only: The DDM is only applicable to companies that currently pay dividends and are expected to continue doing so. It cannot be used for non-dividend-paying stocks or those with erratic dividend policies.
- Sensitivity to Inputs: The model is highly sensitive to changes in its inputs. Small adjustments to D1, r, or g can lead to significant changes in the calculated stock price.
- Estimates: All inputs (D1, r, g) are estimates, and their accuracy directly impacts the reliability of the calculated intrinsic value.
Example Calculation
Let's say you are analyzing a company with the following characteristics:
- Expected Dividend Per Share Next Year (D1): $2.50
- Your Required Rate of Return (r): 12% (0.12)
- Estimated Constant Dividend Growth Rate (g): 6% (0.06)
Using the formula:
Stock Price = $2.50 / (0.12 - 0.06)
Stock Price = $2.50 / 0.06
Stock Price = $41.67
According to the Gordon Growth Model, the intrinsic value of this stock would be approximately $41.67. If the current market price is significantly lower, it might be considered undervalued, and vice-versa.
While the DDM is a powerful tool for valuing mature, dividend-paying companies, it should be used in conjunction with other valuation methods and a thorough understanding of the company's financials and industry dynamics.