What does the Dividend Discount Model assert about stock value?

• A. The value of a stock is equal to the present value of all future dividends.
• B. The value is based on current earnings alone.
• C. Value equals current dividend yield.
• D. Value equals market price.

Answer: (A)

The Dividend Discount Model values a stock by the present value of all expected future dividends, discounted at the investor’s required rate of return. In other words, the price today reflects the sum of each future dividend divided by (1 plus the return) raised to the power of how far in the future it is. If dividends are assumed to grow at a constant rate, this simplifies to the next dividend divided by the difference between the required return and the growth rate. This makes clear why value isn’t based on current earnings, the current dividend yield, or the present market price—the input is the stream of future cash flows to shareholders, and the price is what those cash flows are worth today when discounted.