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The Dividend Discount Model

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Given that dividend yields are at very low levels for US firms, what effect does that have on the applicability of the dividend discount model?

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This solution discusses the applicability of the dividend discount model in 550 words.

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The dividend discount model is a classic formula that explains the underlying value of a share, and it is a staple of the capital asset pricing model which, in turn, is the basis of corporate finance theory. According to the model, a share is worth the sum of all its prospective dividend payments, 'discounted back' to their net present value. As dividends are a form of cash flow to the investor, they are an important reflection of a company's value.

source: http://www.investopedia.com/articles/fundamental/03/102903.asp

Thus, the low dividend yields of US firms implies that the dividend discount model is very difficult to apply for such firms as the basic premises behind the use of such model to value a company is the prospect of future dividends to be paid by the firm to its shareholders.

However, one must note that dividend discount model ...

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Sandeep Bardia, MBA
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  • BCom, SGTB Khalsa College, University of Delhi
  • MBA, Rochester Institute of Technology
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