An instrument designed to compute the intrinsic value of a stock based on a future series of dividends that grow at a constant rate. This tool uses the dividend discount model formula, factoring in the current dividend per share, the required rate of return for equity investors, and the anticipated constant growth rate of dividends. For instance, inputting a $2 current dividend, a 10% required return, and a 5% growth rate would yield an estimated stock value based on those parameters.
Its significance stems from its ability to provide a simplified valuation estimate, crucial for investment decision-making. It enables investors to assess whether a stock is undervalued or overvalued, supporting informed capital allocation. Historically, this method gained prominence as a practical application of dividend discount models, offering a tangible framework for valuing companies with a consistent dividend payout history and predictable growth. Its utility has been demonstrated across various market conditions, albeit with recognized limitations related to its assumptions.
