Multistage Dividend Discount Model

What is the Multistage Dividend Discount Model?

The multistage dividend discount model is an equity valuation model that expands on the Gordon growth model by applying fluctuating growth rates to the calculation. Under the multistage model, changing growth rates are applied to different time periods. Different versions of the multistage model exist, including the two-stage, H, and three-stage models.

Understanding the Multistage Dividend Discount Model

The Gordon growth model solves for the present value of an infinite series of future dividends. These dividends are assumed to develop at a steady rate in perpetuity. Given the model's simplicity, it is generally just used for companies with stable growth rates, for example, blue-chip companies. These companies are well established and consistently pay dividends to their shareholders at a regular pace, given their steady cash flows.

The multistage dividend discount model, an equity valuation model, expands on the Gordon growth model by applying a multitude of growth rates to the calculation.

• The multistage dividend discount model provides practicality for users when esteeming the most dividend-paying companies inside the business cycle.
• This model can be used inside the variance of the business cycle and covers for steady and strange financial activities.
• The multistage dividend discount model has an unstable initial growth rate and is flexible, as it tends to be either negative or positive.

The multistage dividend discount model takes into consideration greater complexity and practicality when esteeming the majority of dividend-paying companies that fluctuate with business cycles, as well as steady and unexpected financial difficulties (or successes). The multistage dividend discount model has an unstable initial growth rate and can be either positive or negative. This initial phase goes on for a specified time frame and is followed by stable growth that endures forever.

Even this model has its constraints; however, it assumes that the growth rate from the initial phase will become stable overnight. Consequently, the H-model has an initial growth rate that is already high, followed by a decline to a stable growth rate over a more steady period. The model assumes that a company's dividend payout ratio and cost of equity remain consistent.

The multistage dividend discount model is normally used exclusively for companies like blue-chip companies.

At last, the three-stage model has an initial phase of stable high growth that goes on for a specified period. In the second phase, growth declines linearly until it reaches a last and stable growth rate. This model improves upon both previous models and can be applied to nearly all organizations.

Multistage Dividend Discount Model and Additional Forms of Equity Valuation

Equity valuation models fall into two major categories: absolute or intrinsic valuation methods and relative valuation methods. Dividend discount models (counting the Gordon growth model and multi-stage dividend discount model) belong to the absolute valuation category, alongside the discounted cash flow (DCF) approach, residual income, and asset-based models.

Relative valuation approaches include comparables models. These involve working out multiples or ratios, like the price-to-earnings or P/E multiple, and comparing them to the multiples of other comparable firms.