Dividend growth model

In this lesson

1. 0:00 Dividend growth model introduction
2. 1:58 Two dividend growth formulas explained
3. 2:32 Worked example: calculating cost of equity
4. 4:21 Model assumptions and limitations
5. 5:08 Estimating growth rate: geometric average
6. 7:01 Calculating historical growth from dividends
7. 10:15 Growth rate from reinvestment levels
8. 12:48 How dividend growth fundamentals work

About this lesson

The dividend growth model assumes shareholders expect dividends to grow at a constant rate each year, so the current share price reflects the present value of all future dividend payments discounted at the required return on equity. You'll work through two core formulas provided in your exam. The first calculates share price when you know the cost of equity; the second rearranges to find the cost of equity when you know the share price. The lesson walks you through a practical example step by step, showing how to substitute values correctly and avoid common pitfalls like confusing ex-dividend prices or mixing units. The lesson then covers how to estimate the growth rate in two ways. The geometric average method uses historical dividend data and compound growth calculations to work backwards and find the rate. Alternatively, Gordon's growth approximation uses the earnings retention method: growth equals the proportion of earnings retained and reinvested, multiplied by the return on those investments. Both approaches are essential when the growth rate isn't explicitly given in an exam question. Throughout, you'll see how the model's key assumptions—constant growth, available share prices and dividends—affect its practical use, and how to adjust for real-world scenarios where growth may vary or dividends are about to be paid.

Duration: 14m