According to the dividend discount model, how is the stock price calculated?

The dividend discount model (DDM) is a valuation method used to determine the price of a stock based on the predicted dividends it will generate in the future. This model is particularly effective when valuing companies that pay regular dividends and whose growth can be estimated.

In the context of this model, the stock price is calculated using the formula that accounts for the expected growth rate and the required rate of return. This formula states that the price of the stock is equal to the expected dividend in the next period, which can be calculated by taking last year’s dividend and adjusting it for growth, divided by the difference between the discount rate and the growth rate.

Specifically, the calculation begins with last year's dividend, increases it by the expected growth rate (hence the (1 + growth rate) part), and then divides the result by the difference between the discount rate and the growth rate. This approach reflects the present value of an infinite series of future dividends that are expected to grow at the specified growth rate.

By utilizing this method, investors can derive a intrinsic value of the stock based on the anticipated future cash flows in the form of dividends, adjusted for their respective risks through the discount rate. Thus, the formula accurately captures both the expected growth of dividends