FINANCE • PRACTICAL BUSINESS GUIDES
Dividend Discount Model: Gordon Growth and Two-Stage Valuation
By Taylor Frizzell, MBA • October 22, 2026
The dividend discount model estimates a share’s value from expected future dividends. It is most useful when dividend policy can be forecast and distributions reasonably reflect the company’s capacity to pay shareholders. Its usefulness depends on the business and the assumptions, not simply whether a dividend was paid last year.
The valuation perspective
Equity value per share = Present value of expected dividends per share. Discount common dividends at a required return on common equity. WACC is appropriate to a different cash-flow perspective and should not replace the cost of equity here. Use consistent currency, per-share amounts, dates, and nominal or real assumptions.
Gordon growth formula
P0 = D1 ÷ (r − g). D1 is the dividend expected one period from today, r is the required equity return, and g is perpetual dividend growth. The model requires r greater than g and a sustainable stable-growth policy.
Original example: $34.67 per share
Assume a hypothetical company just paid an annual dividend of $2.00 per share. Forecast 4% growth indefinitely and require a 10% equity return. These are teaching assumptions, not market estimates.
| Step | Calculation | Result |
|---|---|---|
| Next dividend D1 | $2.00 × 1.04 | $2.08 |
| Required-return gap | 10% − 4% | 6% |
| Estimated value | $2.08 ÷ 6% | $34.67 |
The $2.00 just paid is D0; it is not the numerator for next year’s dividend. At the estimated value, the next-dividend yield is 6%, which combines with 4% modeled growth to give the assumed 10% required return. This identity is not a promise of the actual investor return.
Growth must be supported
A company cannot increase payouts indefinitely without considering earnings, reinvestment, funding, and constraints. Examine payout ratios, retained earnings, future returns on reinvestment, debt obligations, and cash generation. A temporary special dividend does not establish a recurring base. High current yield can reflect distress or an expected cut.
Two-stage valuation
For a separate scenario, keep D0 at $2.00 but assume dividend growth of 8% for three years, followed by 4% forever. Keep the required equity return at 10%, with dividends paid at year-end.
| Dividend | Calculation | Unrounded amount |
|---|---|---|
| D1 | $2.00 × 1.08 | $2.160000 |
| D2 | D1 × 1.08 | $2.332800 |
| D3 | D2 × 1.08 | $2.519424 |
| D4 | D3 × 1.04 | $2.62020096 |
Terminal equity value at the end of year 3 is D4 ÷ (10% − 4%) = $43.670016 per share. The present value of dividends 1–3 is $5.784451. The present value of terminal value is $43.670016 ÷ 1.10^3 = $32.809929.
Value today = $5.784451 + $32.809929 = $38.594380, or $38.59 per share.
D3 is included once in the explicit forecast. The year-3 terminal value represents dividends from year 4 onward. Do not add the undiscounted terminal figure to today’s dividend present values.
Stable-growth sensitivity
For the first Gordon-growth example, hold D0 at $2.00 and change the required return and perpetual growth assumptions. Values below are dollars per share, rounded.
| Required return / growth | 3% | 4% | 5% |
|---|---|---|---|
| 9% | $34.33 | $41.60 | $52.50 |
| 10% | $29.43 | $34.67 | $42.00 |
| 11% | $25.75 | $29.71 | $35.00 |
The wide range shows how strongly the answer depends on long-run assumptions. Selecting growth close to the discount rate to reach a desired price is not a defensible valuation method.
When another approach may fit better
| Situation | Analytical response |
|---|---|
| Stable dividends aligned with capacity | DDM may be useful with sustainable assumptions |
| No near-term dividend but a credible later payout policy | Explicitly model the transition rather than assume no value |
| Large buybacks or payouts far below capacity | Consider FCFE or a carefully specified total-payout model |
| Unstable financing and operating performance | Use scenarios and a method suited to available evidence |
Do not add repurchases to dividends without addressing share-count changes and the chosen model. A standard dividend model values equity directly; do not subtract company debt from its result as though it were enterprise value.
Excel instructions
With D0 in B2, growth in B3, and required return in B4, use =B2*(1+B3)/(B4-B3). In a two-stage model, forecast each dividend separately, calculate the first stable-stage dividend, and discount the terminal value from the last explicit year’s end. Keep full precision until presentation.
Common mistakes
Do not confuse annual and quarterly rates, use dividend yield as the complete required return, forecast growth at or above r forever, or treat an uncertain dividend as contractual. Dividend policy can change. Check special payouts, dilution, and the economic ability to fund distributions.
Frequently asked questions
Does a company with no dividend have no value?
No. It may reinvest profit or make distributions later. A DDM needs a credible eventual payout model; another valuation method may be more practical.
Is the terminal value an assumed sale?
It summarizes later dividend rights. A modeled future share price and remaining dividends must be consistent to avoid double-counting.
Does estimated value above market price prove a buying opportunity?
No. Review forecast risk, method fit, and information already reflected in the price. A model estimate is conditional on its assumptions.
Sources and related guides
Educational sources: CFA Institute: Discounted Dividend Valuation and CFA Institute: Equity Valuation Concepts and Basic Tools. Numerical examples are original hypothetical illustrations.
Continue with Cost of Equity, Terminal Value, FCFF vs. FCFE, and DCF Valuation. Return to the Finance hub.