What is the Dividend Discount Model?

The Dividend Discount Model (DDM) is a method for valuing a stock, that looks at expected future dividend payouts and adjusts to present value.

If the calculated value is less than the current trading price, the security is thought to be undervalued. The DDM is helpful as a tool but should not solely be used in valuation calculations. Perhaps its biggest flaw is that future dividends have to be projected and assumed, which is a far-from-certain practice.

Companies can change or eliminate dividends essentially at will, so the model can be thrown into disarray if the assumptions about future dividend payouts turns out to be incorrect.

Still, it is a useful tool as one of many inputs when valuing a company.