Page 26 - FINAL CFA II SLIDES JUNE 2019 DAY 7

LOS 29.i: Explain the assumptions and justify the selection of the READING 29: DISCOUNTED DIVIDEND VALUATION
two-stage DDM, the H-model, the three-stage DDM, or spreadsheet
modeling to value a company’s common shares.
MODULE 29.3: MULTIPERIOD MODELS

Gordon growth model assumes constant dividend growth into perpetuity and that growth rate is below required rates of returns, which is not tenable for
most companies! Which ever resulting multistage model we use,2 things to keep in mind:
• We’re still just forecasting dividends into the future and discounting them back to today to find intrinsic value.
• Over the long term, growth rates tend to revert to a long-run rate approximately equal to the long-term growth rate in real GDP + long-term inflation rate.
Historically, that’s between 2% and 5%. Anything difficult to justify!

Figure 29.1: Example of a Two-Stage DDM H-Model: The problem with the basic two-stage DDM is
that it is usually unrealistic to assume that a stock will
experience high growth for a short period, then immediately
fall back to a long-run level.

A more realistic assumption: the growth rate starts out
high and then declines linearly over the high-growth
stage until it reaches the long-run average growth rate.

Spreadsheet modeling: In practice we can use spreadsheets to model
any pattern of dividend growth we’d like with different growth rates for each
year because the spreadsheet does all the calculations for us. Applicable to
firms about which you have a great deal of information and can project
different growth rates for differing periods, such as construction firms and
Three-stage DDM: Appropriate for defense contractors with many long-term contracts.
firms that are expected to have three
distinct stages of earnings growth.