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Back out a required return from any DDM, including the H-model and the Gordon growth model

CFA® Level II · Equities · Discounted Dividend Valuation · L2.EQ.2.i

The idea

Any dividend discount model can be solved for the discount rate that makes model value equal the market price; that rate is the expected return implied by the price. With the constant-growth model the answer is direct: r = D1 ÷ P0 + g, next year's dividend yield plus growth. With the H-model, in which growth starts at gS and declines linearly to the long-run rate gL over 2H years, the implied return is r = (D0 ÷ P0) × [(1 + gL) + H × (gS − gL)] + gL. Two- and three-stage models need trial and error or a spreadsheet IRR function. A common trap is adding growth to the trailing yield D0 ÷ P0 rather than the forward yield.

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