Explain disadvantages of dividend discount model.

Expert Solution

Dividend discount model is a model used extensively in valuation of stocks. According to the model, the price of the stock is equal to the present value of all future dividends.

The key drawbacks associated with the model are :

1) Many companies do not give any dividends to shareholders. Thus, the model cannot be used to calculate the stock price for such companies. Mostly stable and mature companies give predictable dividends.

2) It is based on an assumption that the income for shareholders is only based on dividends. Also, the earning of company and dividend it distributes may not be related.

3) It doesn't account for stock buybacks, which is also one of the ways to distribute earnings to shareholders.

4) Difficulty in projection of dividends for future years. Dividends may vary each year and it is difficult to project with certainly the future dividends.

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jeff jeffy answered 1 year ago

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Explain disadvantages of dividend discount model.

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