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When solving the Dividend Discount Model (DDM) equation, why can't the price be calculated if the...

When solving the Dividend Discount Model (DDM) equation, why can't the price be calculated if the growth rate (g) is greater than the required return (r or k)?

Please use logical and real life reasoning and examples

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Answer #1

As per the dividend discount model the intrinsic value of a stock is calculated as D1 divided by K - g. If the growth rate is greater than the required rate of return the denominator will become negative and the value of the stock will also become negative which is unrealistic.

Consider an example where the investor requires a rate of return of 10% on the stock but the stock is actually growing at a rate of 12%. In such a case the investor would not feel the need to value the stock at all because he would be getting a higher compensation for taking a long position in the stock. Such a stock would have an infinitely high price.

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