CFA Level 2 | Equity Valuation: Multi-Stage Dividend Discount Model (DDM)

CFA Level 2

Topic: Equity Valuation

Reading: Discounted Dividend Valuation

The multi-stage dividend discount model is used to value dividend paying stocks, with each stage representing a different dividend growth assumption. The example in the video below illustrates a three-stage dividend discount model, with the following assumptions:

Stage 1: 20% p.a. growth in dividends from Year 1 to Year 3

Stage 2: 10% p.a. growth in dividends from Year 4 to Year 5

Stage 3: 4% p.a. constant growth rate from Year 6 onwards

Steps to Calculate Intrinsic Value using the Multi-stage dividend discount model:

1. Calculate the dividends for Stage 1 and Stage 2.
2. Calculate the terminal value at the end of Year 5 (end of Stage 2). Basically at the end of the period before the growth becomes constant.
3. Discount the dividends and terminal value to arrive at the intrinsic value. (TIP: Make use of the Cashflow worksheet to key in the dividends and terminal value, then use the NPV function to compute the intrinsic value.)

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