Dividend Discount Model (DDM)

Let’s imagine you’re evaluating a mango orchard, not for how many mangoes it will produce to sell in the market, but because it pays you a fixed share of mangoes every year — like a dividend. Now, how would you value that orchard? You’d look at how much fruit it gives you each year, and how reliably it does so. That’s the heart of the Dividend Discount Model (DDM) — a valuation method focused on the dividends a company pays its shareholders.

What is DDM?

The Dividend Discount Model is a type of intrinsic valuation used to estimate the fair value of a company based on its future dividend payments. It works on the principle that the value of a stock is equal to the present value of all its expected future dividends. This method is particularly useful for valuing companies that pay stable and predictable dividends, like large banks, FMCG companies, and utilities.

The Basic Formula:

Value of Stock = D1 / (r - g)

Where:

• D1 = Dividend expected next year
  
• r = Required rate of return (or discount rate)
  
• g = Dividend growth rate
  

Example: Suppose Hindustan Unilever is expected to pay a dividend of ₹20 next year. If the dividend is expected to grow at 6% annually and your required rate of return is 10%, the fair value of the stock using DDM would be:

So, according to the model, the fair value of the share is ₹500.

Where is DDM Most Useful?

• Companies with consistent dividend-paying history
  
• Financial sector stocks like banks and insurance firms
  
• Blue-chip companies with limited reinvestment needs
  

Limitations of DDM:

• Not useful for companies that do not pay dividends
  
• Very sensitive to assumptions of growth rate and discount rate
  
• Doesn’t account for buybacks or capital appreciation
  

Many investors use DDM to value companies like ITC, Coal India, or public sector banks — firms that offer stable dividend policies and predictable payout patterns.

The Dividend Discount Model works like valuing a mango tree that feeds you regularly. If that stream is stable and likely to grow, the tree becomes more valuable. In the next chapter, we’ll look at Comparable Company Analysis (CCA) — a relative valuation technique that benchmarks your company against others in the same industry.