Calculate the fair value of any dividend stock using the Gordon Growth Model. Find out if a stock is overvalued or undervalued in minutes.
The simplest and most widely used dividend discount model
Intrinsic Value = D1 / (r - g)
D1
Expected dividend next year
(Current dividend x (1 + growth rate))
r (Required Return)
Your minimum acceptable return
(Typically 8-12% for stocks)
g (Growth Rate)
Expected dividend growth rate
(Must be less than r)
Quick Example: Coca-Cola (KO)
Note: This simplified result highlights why the DDM works best when combined with other valuation methods. A 10% required return may be too high for a defensive blue-chip like KO.
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Calculation
At a 9% required return, the DDM suggests JNJ is slightly overvalued. However, lowering the required return to 8% (reasonable for a low-risk Dividend King) gives a value of $200.80, making it look undervalued. This sensitivity is a key consideration.
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Calculation
AbbVie's high dividend growth rate (10.5% over 10 years) combined with a large current dividend gives a high intrinsic value. The DDM suggests ABBV is undervalued, which aligns with its reputation as a top dividend growth stock.
The basic Gordon Growth Model assumes dividends grow at a constant rate forever. In reality, many companies grow dividends faster when young and slower as they mature. The two-stage DDM addresses this.
Two-Stage DDM Approach
Stage 1: High Growth (Years 1-10)
Use the company's current dividend growth rate. For fast growers like Visa, this might be 12-15% annually. Calculate each year's dividend individually and discount back to present value.
Stage 2: Stable Growth (Year 11+)
Assume growth slows to a sustainable long-term rate (3-5%, roughly GDP growth). Apply the Gordon Growth Model to calculate the terminal value, then discount it back to present.
Two-Stage Example: Visa (V)
Stage 1: Dividends grow at 12% for 10 years (D0 = $2.36)
Stage 2: Dividends grow at 4% forever (terminal growth rate)
Required return: 10%
PV of Stage 1 dividends: ~$24.50
Terminal value at Year 10: $2.36 x (1.12)^10 x 1.04 / (0.10 - 0.04) = $126.91
PV of terminal value: $126.91 / (1.10)^10 = $48.93
Total intrinsic value: $24.50 + $48.93 = $73.43
Current price: ~$310. Visa trades at a premium because the market expects long-duration growth that exceeds what conservative DDM inputs capture.
The DDM cannot value companies that do not pay dividends (Amazon, Tesla, Meta until recently). It is best suited for mature, consistently dividend-paying companies like Coca-Cola, J&J, or Procter & Gamble.
Small changes in the required return or growth rate drastically change the result.
Example: A stock with $2 dividend and 5% growth. At r=10%: value = $42. At r=9%: value = $52.50. At r=8%: value = $70. Just a 2% change in required return changes the value by 67%.
If g is greater than or equal to r, the formula produces a negative or infinite number, which is meaningless. This means the basic DDM breaks down for high-growth companies. Use the multi-stage model for stocks with growth rates above 8%.
The DDM gives a useful baseline valuation, but combine it with P/E ratios, free cash flow analysis, and peer comparisons. If the DDM says a stock is undervalued AND other metrics agree, you have a stronger conviction signal.
Low-Risk Blue Chips
JNJ, PG, KO, PEP
Average Dividend Stocks
ABBV, TXN, HD, CVX
Higher-Risk Dividend Payers
REITs, BDCs, MLPs
A common approach is to use the CAPM (Capital Asset Pricing Model): r = risk-free rate + beta x equity risk premium. With the 10-year Treasury at ~4.5% and a 5.5% equity risk premium, a stock with beta 0.8 would have r = 4.5% + (0.8 x 5.5%) = 8.9%.
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