Building Modular Dividend Discount Models Using a 'Super Annuity Formula'

Abstract

The dramatic increase in the importance of U.S. dividends since 2001 means that financial analysts may soon demand access to updated dividend discount models (DDMs). To address this need, we introduce a new “super annuity formula” that can be used in the modular construction of multiple-stage level-growth DDMs. We also use the super annuity formula to approximate a three-stage transitional-growth DDM very accurately. We show that these advanced DDMs are relatively robust to the input assumptions. Going forward, every financial analyst should have knowledge of and access to these updated DDMs, so as to capitalize on the growing importance of dividends.

Keywords: dividend discount models, valuation, annuities

JEL Classification: G12, G32, G35