Dividend discount models use which of the following to value stock?

Dividend discount models use which of the following to value stock?

• A. An approach that uses revenue growth to value stock.
• B. It prices stock solely based on book value.
• C. Dividend discount models use dividends to value stock.
• D. It prices stock based on dividend yield alone.

Answer: (C)

Dividend discount models value a stock by the present value of expected dividends. The idea is that a stock’s worth today is the sum of all future cash payments to shareholders, discounted back at the required return. If dividends are expected to grow at a constant rate, the price is D1 divided by (r minus g), where D1 is the next dividend and r is the required return. This framework directly uses dividends to determine value, rather than revenue growth or book value, and it considers both the size and timing of payments rather than just the yield. For example, if the next dividend is $2, the required return is 8%, and growth is 3%, the value would be 2 / (0.08 − 0.03) = 40.

Dividend discount models value a stock by the present value of expected dividends. The idea is that a stock’s worth today is the sum of all future cash payments to shareholders, discounted back at the required return. If dividends are expected to grow at a constant rate, the price is D1 divided by (r minus g), where D1 is the next dividend and r is the required return. This framework directly uses dividends to determine value, rather than revenue growth or book value, and it considers both the size and timing of payments rather than just the yield. For example, if the next dividend is $2, the required return is 8%, and growth is 3%, the value would be 2 / (0.08 − 0.03) = 40.