Discounted Dividend

Section: Discounted Dividend Valuation Estimated study time: 60 minutes Content: Discounted dividend valuation models estimate intrinsic stock value as the present value of all expected future dividends. The Gordon Growth Model (GGM), also called the Dividend Discount Model (DDM), is the simplest and most widely applied form: P0 = D1 / (r - g), where P0 is the current intrinsic value, D1 is the expected dividend one period from now (D0 * (1+g)), r is the required return on equity, and g is the constant perpetual growth rate. The model requires r > g to produce a finite positive value. At CFA Level 2, the single-stage GGM is extended to multi-stage DDMs for companies with non-constant growth, and candidates must apply these models under realistic scenarios where growth rates, required returns, and payout ratios change over time. The required return on equity is typically estimated using the Capital Asset Pricing Model (CAPM): r = rf + beta*(rm - rf), where rf is the risk-free rate, beta is the stock's systematic risk, and (rm - rf) is the equity risk premium (ERP). At Level 2, candidates must understand that the ERP is not directly observable and must be estimated — approaches include using historical excess equity returns, a forward-looking implied ERP derived from current market prices and earnings/dividend forecasts, or survey-based estimates. The implied ERP solves: Index Level = Sum of present value of forecast dividends. Mature market equity risk premiums are typically estimated at 4-6%. Country risk premiums are added for emerging markets using sovereign yield spreads or volatility-based adjustments. The sustainable growth rate is a critical input: g = ROE * b, where b = (1 - payout…