(DDM) Dividend Discount Model Help
Hello all, I have a technical interview where I will need to complete a dividend discount model in less than an hour. Does anyone have good advice on where to learn how to do this model or good resources, etc? Thank you all.
To prepare for a Dividend Discount Model (DDM) in under an hour, here’s what you need to know:
Key Resources:
Based on the most helpful WSO content, you can explore the DCF Modeling Training - Free Guide available in the Financial Modeling Resources section. While it focuses on discounted cash flow, the principles of discounting and valuation overlap with DDM.
Steps to Build a DDM:
$$ \text{Terminal Value} = \frac{\text{Dividend at Year n+1}}{\text{Cost of Equity} - \text{Growth Rate}} $$
Templates:
WSO offers Financial Modeling Templates (.xlsx) that might include pre-built DDM frameworks. These can save time and help you understand the structure.
Practice:
Use the WSO Free Modeling Series, which includes lessons taught by experienced professionals. This series provides practical insights into financial modeling, including valuation techniques.
Tips for the Interview:
Good luck with your interview!
Sources: Resources for learning about distressed debt investing, Data Dump | The Daily Peel, Discounted Discounts | The Daily Peel | 10/26/21, Valuing a Division of a Company (DCF)
DDM itself is not the difficult part, but rather the operating build that leads to the dividends that end up getting discounted. I would describe a DDM as a DCF with "extra traffic"... so let's assume you're dealing with a bank, which is the business which most frequently requires a DDM.
Bank operating model is driven off the B/S, not the I/S and the CFS is mostly meaningless. You project out loans for interest income / NIM and then your non-interest income is usually driven by auxiliary divisions, such as wealth mgmt. but that's just bps on AUM or whatever. Then burden all this income generation for expense as you would any other business and you get down to net income (or what for a non-B/S business would be EBITDA, which eventually bridges you to FCF).
Once you're at net income, you apply the payout ratio - so how much of in-year net income goes to dividends - but always burdened for what your equity on B/S is - because here is where we have to apply certain ratios to restrict distribution of dividends - these are the CET1 ratios for banks, statutory / Solvency II (if EU) capital ratios for insurers, TLAC for spec. fin. businesses, etc. each flavor has its own version - and if you meet that "target ratio" then you can release xyz amount of dividends. Mechanically, it's like a "double IF" statement, where you hit the higher of the xyz payout ratio or whatever dividend payout ratio allows you to maintain xyz regulatory capital ratio.
The reason you use DDMs and not DCFs for things like banks btw is b/c FCF does NOT "exist" for them since "debt is raw material" wherein debt = deposits / any other source of financing. In essence, and "corporate financially", the dividends for a bank are effectively = FCF for any other business.
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