DDM isn’t only about dividends. It also factors in expected growth rates and risk, making it a powerful tool for long-term stock valuation.
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The most common version of DDM, the Gordon Growth Model, assumes dividends grow at a constant rate forever. But in reality, many companies have irregular dividend policies.
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DDM tends to underestimate the value of tech and high-growth companies that reinvest profits rather than pay dividends, leading to undervaluation of these firms.
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DDM isn’t just for individual stock valuation—investment bankers use it to assess the value of entire companies during mergers and acquisitions.
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The model works best with stable, blue-chip companies that have a long history of dividend payments, like Procter & Gamble or Coca-Cola.
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DDM is highly sensitive to changes in interest rates. As rates rise, DDM tends to undervalue stocks due to higher discount rates.
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DDM isn’t suitable for all industries. Capital-intensive businesses or those with fluctuating earnings, like airlines, may not fit well with this model.
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Companies with high dividend payout ratios are often better evaluated using DDM as their dividends are a significant portion of their profits.
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DDM is a favorite among value investors, who focus on income-generating stocks rather than growth-oriented stocks that don’t pay dividends.