For a steady dividend payer, valuation gets beautifully direct: a stock is worth the present value of every dividend it will ever pay you. This is the first of our two intrinsic-value engines — and it's tailor-made for the TSX.
Strip investing to its foundation: when you own a share forever, the only cash you personally receive is dividends. So a share must be worth the present value of all its future dividends. Everything else — price appreciation — is just other investors re-pricing that same future stream. The dividend discount model takes this literally and adds up the discounted dividends.
If dividends grow at a constant rate forever, the infinite sum collapses to one elegant formula:
where D₁ is next year's dividend, r is your required return, and g is the perpetual growth rate. It's a perpetuity with growth. Suppose a utility will pay $3.00 next year, you require 9%, and the dividend grows 3% forever: P = 3.00 ÷ (0.09 − 0.03) = 3.00 ÷ 0.06 = $50.00.
| Growth g → Required r ↓ | 2% | 3% | 4% |
|---|---|---|---|
| 8% | $50.00 | $60.00 | $75.00 |
| 9% | $42.86 | $50.00 | $60.00 |
| 10% | $37.50 | $42.86 | $50.00 |
Gordon value of a $3.00 dividend at different r and g. Small input changes, big output changes — the case for ranges, not point estimates.
Three sensible ways to pin down growth, cross-checked against each other:
Required return is your cost of equity. The workhorse estimate is “CAPM lite”:
Use the 10-year Government of Canada (or US Treasury) yield as the risk-free rate, an equity risk premium around 4.5–5.5%, and the stock's beta for its riskiness. A beta of 1.2 with a 3.5% risk-free rate and 5% premium gives r = 3.5% + 1.2 × 5% = 9.5%. (The full weighted-average cost of capital comes in Module 6; for an all-equity DDM, cost of equity is what you need.)
Few companies grow at one rate forever. The two-stage model handles a faster near-term phase reverting to a mature perpetuity: discount each dividend for the first (say) five years at the higher growth rate, then apply the Gordon formula to value everything after that, and discount that terminal value back. It's the same machinery as the DCF you'll meet next module — applied to dividends instead of free cash flow.
The DDM shines for mature, reliable dividend payers: banks, utilities, telecoms and pipelines — which happen to be half the TSX by weight. That makes it unusually useful for a Canadian investor. Run it on a Big Six bank with a long, steady dividend record and you get a defensible number the DCF would struggle to produce (banks break the DCF, as Module 9 explains).
Educational purposes only; not financial advice. Example figures are illustrative. Always do your own research and consult a licensed advisor.