Dividend Discount Model (DDM) – with example

We talked about DDM in previous article (Read more here).  Let’s take one real world example to calculate the stock value using DDM.

PBBank has a good website (link), containing vast amount of financial information on dividend payout policy and also other financial ratios.   From previous article we know that the most important variable in the DDM is the growth rate, g.  Besides using the retention rate, RR and return on equity (ROE) to estimate the g, we can also use historical dividend growth rate to estimate the g.  From the link, we can gather all the required info to do the calculation.

The below Table 1 is the relevant information extracted from the PBBank investor relations website.

Table 1

	2015	2014	2013	2012	2011	Average
Gross dividend per share (RM)^	0.56	0.54	0.52	0.50	0.48	0.52
Dividend payout ratio (1-RR)	42.70%	46.10%	44.80%	45.30%	48.30%	45.44%
Retention rate, RR	57.30%	53.90%	55.20%	54.70%	51.70%	54.56%
Return on equity ^^	17.80%	19.90%	22.40%	24.10%	26.80%	22.20%
g = RR * ROE	10.20%	10.73%	12.36%	13.18%	13.86%	12.07%
g, historical dividend growth rate	3.70%	3.85%	4.00%	4.17%	N/A	3.93%

^             Before fees, tax and other expenses

^^           Not adjusted for non-recurring income or loss, or any other non-core income items, or any other items that required to reflect the real earning power of the company

We can see that the estimated growth rate using two different approached yielded two different results.  In this case, the average growth rate estimation using RR * ROE is 12.07%.  While the retention rate, RR is fairly constant over the years, the ROE is deteriorating fast.  As such, using RR*ROE may not be appropriate for DDM in this case.  Meanwhile, the historical dividend growth rate is deteriorating too but at a lower speed.  As such, to provide sufficient margin of safety, we shall use 3.70% as the growth rate.

The below Table 2 is the DDM for PBBank using various required rate of return, k.  To achieve 5% return, current stock price RM19.34 is well below the estimated value using DDM, which is RM44.67.  But to achieve 10% required rate of return, then the stock price now has to be below RM9.22.

Table 2

Stock price (8-Jul-16)	Dividend 2015	Dividend Yield	D1	k	g	DDM
19.34	0.56	2.90%	0.58072	10%	3.70%	9.22
19.34	0.56	2.90%	0.58072	9%	3.70%	10.96
19.34	0.56	2.90%	0.58072	8%	3.70%	13.51
19.34	0.56	2.90%	0.58072	7%	3.70%	17.60
19.34	0.56	2.90%	0.58072	6%	3.70%	25.25
19.34	0.56	2.90%	0.58072	5%	3.70%	44.67

Disclaimer:  The above stock price calculations do not imply any buy or sell recommendation.   The author disclaims all liabilities arising from any use of the information contained in this article.