Reconciling Dividend Discount and Earnings Recapitalization Valuations

Summary

The document considers why a fictional company’s share value differs when calculated with the Dividend Discount Model (DDM) and an Earnings Recapitalization Model (ERM). The response argues that the setup is inconsistent if projected dividends exceed the earnings available to support them. It illustrates the issue by comparing a perpetual payout with lower perpetual earnings, then notes that the same logic applies when both amounts grow at the stated rate.

The central lesson is to check that a dividend stream is financially supportable before comparing valuation outputs. The post does not provide the company’s full inputs, calculations, or a general formula for reconciling the two methods, so it cannot identify a correct share price here. Its answer is a diagnostic explanation of one possible modeling flaw, rather than evidence that either valuation method is universally preferable.

Key ideas

• A DDM valuation depends on a dividend stream that the company can sustain.
• Perpetual dividends cannot consistently exceed perpetual earnings without further assumptions.
• Apply the same consistency check when dividends and earnings grow at a common rate.
• The document does not supply enough inputs to determine a share price or choose a universally superior model.

Tags

# Reason for difference in share price between DDM and ERM?


# Reason for difference in share price between DDM and ERM?












I've calculated the Share Price of a fictional company both using the Dividend Discount Model (DDM) and the Earnings Recapitaliazation Model (ERM). However, the share prices differ significantly between the two methods. Does anyone know the reasons why the results differ? Which method is preferable / which of the two result is correct?

Information about the company:







- EPS growth rate 3%



The results are (calculated with the perpetuity formula):





Thank you, Peter

## Answer by Mild_Thornberry (score 0, accepted)

https://quant.stackexchange.com/a/64063

Your setup is flawed. Set growth to 0. How can a company pay 5 dollars in perpetuity when it only earns 2 in perpetuity? Add back in growth. How can a company pay 5 dollars growing at 3% in perpetuity when it only earns 2 growing at 3% in perpetuity?

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