Dividend Discount Model

The logic is impeccable — a share's only direct cash return to a passive holder is its dividends — but the application is narrow, because it values only what is paid out and ignores value created by retained earnings until they eventually become dividends. It therefore badly undervalues companies that reinvest heavily and pay little, and is unusable for companies paying nothing. It works best for mature, stable payers such as utilities and large financials with predictable payout policies. Where a company buys back shares instead of paying dividends, the model must be extended to total shareholder distributions or it will understate value.