Dividend Growth Model (DGM)
The Dividend Growth Model (DGM) is a method used to value a company’s Stock by assuming that dividends will grow at a constant rate indefinitely. The model calculates the present value of expected future dividends, which are discounted back to their present value using the required rate of return. The formula for the DGM is:
Price = D / (r – g)
Where:
- Price: The estimated price of the Stock.
- D: The expected dividend next year.
- r: The required rate of return.
- g: The growth rate of the dividends.
For example, if a company is expected to pay a dividend of $3 next year, has a required rate of return of 8%, and an expected dividend growth rate of 5%, the Stock price would be calculated as follows:
Price = 3 / (0.08 – 0.05) = 3 / 0.03 = $100
This implies that the Stock is valued at $100 based on the anticipated growth of dividends.
In cases where dividends grow at varying rates, analysts may use a multi-stage DGM, which accounts for different growth rates over different periods. For instance, if a company expects dividends to grow at 10% for the next 3 years and then at 4% indefinitely, the model would be adjusted accordingly to reflect these changes in growth rates.