You are reading the 2026 curriculum (exams up to November 2026). Sitting in February 2027 or later? Go to the 2027 Equities guide.
Two-stage (multistage) dividend discount model
Forecast dividends year by year through the high-growth phase, then value everything after it with the Gordon formula at the end of that phase: Vₙ = Dₙ₊₁ ÷ (r − g_L). Discount the high-growth dividends and Vₙ back to today and add them up.
Before this: Gordon growth model and preferred stock valuation
On the exam
- Calculate and interpret the intrinsic value of an equity security based on the Gordon (constant) growth dividend discount model or a two-stage dividend discount model, as appropriate
- Identify characteristics of companies for which the constant growth or a multistage dividend discount model is appropriate
Calculate and interpret a two-stage dividend discount model (DDM) value and identify companies that need a multistage model. Expect: the value from a growth path, the terminal value formula, the discounting period for the terminal value, and which company profile needs which model.
How deeply to learn each part
- Know the idea
- Understand it in general. It frames other topics, but you will not calculate with it.
- Use it
- Understand it well enough to solve a question with it. Recognize when it applies.
- Memorize
- Learn it by heart. The exam will not give it to you.
You know this one. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still do.
You tested strong here. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still know it.
How do you value a company whose growth will slow down?
The Gordon model needs one growth rate forever. A company with a hot product has a high growth rate now that cannot last, because competitors arrive and the market fills. The two-stage DDM handles that, and it is the simplest multistage dividend discount model . It gives the company two growth rates: a high rate for a finite number of years , the high-growth phase , and then a lower sustainable rate forever, the mature phase .
- Constant growth (Gordon) Use it already at a sustainable rate; mature
- Two-stage DDM Use it a finite spell of unusually high (or low) growth, then a sustainable rate
- Typical case new product or advantage that fades as competitors arrive
- Also fits an older firm with a temporary burst or dip in growth
-
- Three-stage DDM Know the idea growth, then a transition of declining growth, then maturity
- Typical case a young company just entering its growth phase
-
- Not a dividend model Use it no dividend or dividends unrelated to capacity: FCFE or multiples
The method has two parts. Forecast the dividends of the high-growth phase one at a time, because they follow no single formula over the whole life. Then collapse everything after that into one number at year , the terminal value , using the Gordon model.
The Gordon formula values dividends starting one year after the date it is applied. So , applied at year , values dividends from year on, and it needs . The terminal value is a value at year , so it is discounted years, the same as the year- dividend.
At the end of a high-growth phase, a company's first dividend of the stable phase is 1.92. Stable growth is 5.00% and the required return is 10.00%. The terminal value at that date is closest to:
1.92 ÷ (0.1 − 0.05) = 38.33
Terminal value at the end of the high-growth phase, Vₙ38.33
- 1.916303÷(0.1−0.05)=38.326
- 1.916303ENTER0.1ENTER0.05−÷38.326
ENTER enter (on the HP, puts the number on the stack)
A company's last dividend was 1.20. Dividends will grow 15.00% a year for 3 years and 5.00% a year thereafter. The required return is 10.00%. The share's value is closest to:
PV of dividends 3.94 + PV of V3 (38.33 ÷ 1.1^3) 28.79 = 32.73
Value today, V₀32.73
- CF2NDCLR WORK
- 0ENTER↓1.38ENTER↓↓1.587ENTER↓↓40.1511ENTERthe last flow is D3 + V3
- NPV10ENTER↓CPT32.7322
CF cash flow worksheet · 2ND second function (the shifted label above a key) · CLR WORK clear the worksheet · ENTER enter (on the HP, puts the number on the stack) · NPV net present value · CPT compute
- fCLEAR REG
- 0gCF01.38gCFj1.587gCFj40.1511gCFjthe last flow is D3 + V3
- 10i
- fNPV32.7322
f gold shift key · CLEAR REG clear all registers · g blue shift key · CF0 cash flow at time zero · CFj cash flow j · i interest rate per period · NPV net present value
Try this 0 of 3
- Turn on both traps and compare with the right value
- Push the terminal value's share of today's value above 90%
- Stretch the fast stage to 8 years
| Year | Cash flow | PV |
|---|---|---|
| 1 | D₁ 1.38 | 1.2545 |
| 2 | D₂ 1.587 | 1.3116 |
| 3 | D₃ 1.825 | 1.3712 |
| 3 | V₃ 38.326 | 28.7949 |
| V₀ | 32.73 |
Show working
Fast stage: D₁ = 1.38, D₂ = 1.587, D₃ = 1.825 (each × 1.15).
D₄ = D₃ × (1 + g_L) = 1.825 × 1.05 = 1.9163
V₃ = D₄ ÷ (r − g_L) = 1.9163 ÷ (0.1 − 0.05) = 38.326
PV of dividends = 1.38 ÷ 1.1 + 1.587 ÷ 1.1² + 1.825 ÷ 1.1³ = 3.9373
PV of V₃ = 38.326 ÷ 1.1³ = 28.7949 (discounted 3 years, not 4)
V₀ = 3.9373 + 28.7949 = USD 32.73
- 1.82505×1.05÷(0.1−0.05)=V₃ = 38.326
- CF2NDCLR WORK
- 0ENTER↓CF0
- 1.38ENTER↓↓C01
- 1.587ENTER↓↓C02
- 40.1511ENTER↓↓C03 = D₃ + V₃
- NPV10ENTER↓CPTV₀ = 32.73
CF cash flow worksheet · 2ND second function (the shifted label above a key) · CLR WORK clear the worksheet · ENTER enter (on the HP, puts the number on the stack) · NPV net present value · CPT compute
- 1.82505ENTER1.05×0.1ENTER0.05−÷V₃ = 38.326
- fCLEAR REG
- 0gCF0
- 1.38gCFj
- 1.587gCFj
- 40.1511gCFjD₃ + V₃
- 10i
- fNPVV₀ = 32.73
ENTER enter (on the HP, puts the number on the stack) · f gold shift key · CLEAR REG clear all registers · g blue shift key · CF0 cash flow at time zero · CFj cash flow j · i interest rate per period · NPV net present value
The three classic slips
Each of these changes the answer to the example above, and each appears as an option in exam questions.
| Slip | What it does | Result |
|---|---|---|
| Terminal value from instead of | V₃ = 1.8251 ÷ 0.05 = 36.50 | V₀ = 31.36 |
| Discount for years | 38.33 ÷ 1.10⁴ | V₀ = 30.11 |
| Use in the terminal formula | the formula breaks, because 15% is above r = 10% | no valid value |
The correct answer is 32.73.
How sensitive is it?
Because the terminal value dominates, small changes to or move the result a lot. In the example, with everything else unchanged:
| Long-term growth g_L | V₀ |
|---|---|
| 4% | 27.70 |
| 5% | 32.73 |
| 6% | 40.27 |
| Required return r | V₀ |
|---|---|
| 9% | 41.00 |
| 10% | 32.73 |
| 11% | 27.22 |
Analysts therefore test the terminal value, for example by comparing the multiple it implies with the multiples of mature peers.
Which companies need a multistage model?
Use the stages that match how growth will really behave. A mature company already growing at a sustainable rate suits the Gordon model. A company with an unusually high rate now, perhaps from a new product or a competitive advantage that will fade as rivals arrive, suits two stages. A three-stage DDM suits a young company at the start of its growth phase: growth, then a transition of declining growth, then maturity. Two stages is the better fit for an older company already in transition.
Age is not the only test. An old company can find fresh growth, for example by launching a new product line or buying a rival, and that burst is expected to fade back toward a normal rate. Two stages fit. So does a company going through a weak spell that is expected to climb back to its normal growth rate. The test is the shape of the growth path, not the company’s age.
Exam tip Count the growth regimes you can defend with evidence. One regime: Gordon. Two: two-stage. Three: three-stage. If you cannot defend any, use free cash flow to equity (FCFE) or multiples.
Go deeper A three-stage model without the numbers
Suppose growth is for years, falls to for the next years and then settles at forever. Forecast the dividends year by year through the first two stages. At year compute the terminal value . Discount every dividend and that terminal value to today. The same rule applies: the terminal value is dated at the end of the last explicit stage, and it uses the next dividend.
Go deeper Checking the terminal value
A terminal value is a forecast of what the company will be worth at year . To check it, convert it to a multiple. In the example, of 38.33 against an expected earnings per share can be turned into a P/E and compared with the P/E of mature companies. If the implied multiple is far above what mature peers trade at, the long-term growth rate or the required return is probably too generous. The next lesson shows how a multiple relates to and .
Memorize this
MemorizeTwo-stage DDM in four steps
| Step | What to do |
|---|---|
| 1 | Grow D₀ at g_S to get D₁ … Dₙ |
| 2 | Find Dₙ₊₁ = Dₙ × (1 + g_L) |
| 3 | Vₙ = Dₙ₊₁ ÷ (r − g_L), valued at year n |
| 4 | V₀ = PV of D₁ … Dₙ + Vₙ ÷ (1 + r)ⁿ |
Memory hook The Gordon value sits one year before its first dividend, so the dividend you need is the one AFTER the high-growth phase.
Know it cold Discount Vₙ for n years (not n + 1). Use g_L in the terminal formula, never g_S. Terminal value is usually most of the answer.
MemorizeWhich model suits which company
| Company | Model |
|---|---|
| Mature, stable payout, growth below r | Gordon growth |
| High growth now, will fade to a sustainable rate | two-stage |
| Young: growth, then transition, then maturity | three-stage |
| No dividend or erratic dividends | FCFE or multiples |
Memory hook One stage per distinct growth regime you can defend.
Know it cold The long-term growth rate must stay below r and near the economy's growth.
- Constant growth (Gordon) Use it already at a sustainable rate; mature
- Two-stage DDM Use it a finite spell of unusually high (or low) growth, then a sustainable rate
- Typical case new product or advantage that fades as competitors arrive
- Also fits an older firm with a temporary burst or dip in growth
-
- Three-stage DDM Know the idea growth, then a transition of declining growth, then maturity
- Typical case a young company just entering its growth phase
-
- Not a dividend model Use it no dividend or dividends unrelated to capacity: FCFE or multiples
Quick example
D₀ = 2.00, growth 10% for two years then 4%, r = 9%. D₁ = 2.20, D₂ = 2.42, V₂ = 2.5168 ÷ 0.05 = 50.336. V₀ = 2.20 ÷ 1.09 + (2.42 + 50.336) ÷ 1.09² = 46.42.
- CF2NDCLR WORK
- 0ENTER↓2.2ENTER↓↓52.756ENTER
- NPV9ENTER↓CPT 46.4220
CF cash flow worksheet · 2ND second function (the shifted label above a key) · CLR WORK clear the worksheet · ENTER enter (on the HP, puts the number on the stack) · NPV net present value · CPT compute
- fCLEAR REG
- 0gCF02.2gCFj52.756gCFj9i
- fNPV 46.4220
f gold shift key · CLEAR REG clear all registers · g blue shift key · CF0 cash flow at time zero · CFj cash flow j · i interest rate per period · NPV net present value
Quick example
The last high-growth dividend is 1.80 (year 3), g_L = 3%, r = 9%. D₄ = 1.80 × 1.03 = 1.854 and V₃ = 1.854 ÷ 0.06 = 30.90.
- 1.8×1.03÷(0.09−0.03)= 30.9
- 1.8ENTER1.03× D₄
- 0.09ENTER0.03− r − g
- ÷ 30.9
ENTER enter (on the HP, puts the number on the stack)
Quick example
D₀ = 1.20, three years at 15%, then 5%. D₄ = 1.20 × 1.15³ × 1.05 = 1.9163.
- 1.2×1.15×1.15×1.15×1.05= 1.9163
- 1.2ENTER1.15×1.15×1.15×1.05× 1.9163
ENTER enter (on the HP, puts the number on the stack)
How it is asked
-
Two-stage value
D₀ 2.00; 10% for 2 years; then 4%; r 9%.
V₂ = 2.5168 ÷ 0.05 = 50.336; V₀ = 46.42. Traps: 44.79 (V₂ from D₂), 42.92 (discounted 3 years).
-
Terminal value formula
The terminal value at the end of the high-growth phase uses which dividend?
The first dividend of the stable-growth period, Dₙ₊₁. Trap: Dₙ.
-
Which model
Fast growth from a new product, expected to slow to industry growth.
Two-stage DDM.
-
Share of terminal value
Why is Vₙ so large in a growth company?
It holds every dividend from year n + 1 to infinity.
Exam traps
- Computing Vₙ from Dₙ instead of Dₙ₊₁. The Gordon formula needs the next dividend.
- Discounting Vₙ for n + 1 years. Vₙ is a value at year n, so discount it n years.
- Using the high growth rate g_S in the terminal formula. After year n, growth is g_L.
- Using a long-term growth rate at or above the required return, or well above the growth of the economy.
Checkpoint
5 exam-style questions. About 90 seconds each.
1A company's dividend was USD 2.00 last year. Dividends will grow 10% a year for two years and 4% a year thereafter. The required return is 9%. The share's value is closest to:
2A two-stage dividend discount model is most appropriate for a company that:
3In a two-stage DDM, the terminal value at the end of the high-growth period is calculated using:
4A company's last dividend of its high-growth phase, in year 3, is GBP 1.80. After that, dividends grow 3% a year. The required return is 9%. The terminal value at the end of year 3 is closest to:
5A young company has just entered a period of rapid growth. Analysts expect growth to decline gradually over several years before settling at a mature rate. The dividend discount model that best fits this pattern is the:
Key takeaways
- Forecast the high-growth dividends one by one.
- Vₙ = Dₙ₊₁ ÷ (r − g_L), discounted n years.
- Terminal value usually dominates, so check g_L and r first.
- Use two stages for fading growth, three for a young company, Gordon only for mature stable payers.
Quick example
D₀ = 2.00, growth 10% for two years then 4%, r = 9%. D₁ = 2.20, D₂ = 2.42, V₂ = 2.5168 ÷ 0.05 = 50.336. V₀ = 2.20 ÷ 1.09 + (2.42 + 50.336) ÷ 1.09² = 46.42.
- CF2NDCLR WORK
- 0ENTER↓2.2ENTER↓↓52.756ENTER
- NPV9ENTER↓CPT 46.4220
CF cash flow worksheet · 2ND second function (the shifted label above a key) · CLR WORK clear the worksheet · ENTER enter (on the HP, puts the number on the stack) · NPV net present value · CPT compute
- fCLEAR REG
- 0gCF02.2gCFj52.756gCFj9i
- fNPV 46.4220
f gold shift key · CLEAR REG clear all registers · g blue shift key · CF0 cash flow at time zero · CFj cash flow j · i interest rate per period · NPV net present value
Quick example
The last high-growth dividend is 1.80 (year 3), g_L = 3%, r = 9%. D₄ = 1.80 × 1.03 = 1.854 and V₃ = 1.854 ÷ 0.06 = 30.90.
- 1.8×1.03÷(0.09−0.03)= 30.9
- 1.8ENTER1.03× D₄
- 0.09ENTER0.03− r − g
- ÷ 30.9
ENTER enter (on the HP, puts the number on the stack)
Quick example
D₀ = 1.20, three years at 15%, then 5%. D₄ = 1.20 × 1.15³ × 1.05 = 1.9163.
- 1.2×1.15×1.15×1.15×1.05= 1.9163
- 1.2ENTER1.15×1.15×1.15×1.05× 1.9163
ENTER enter (on the HP, puts the number on the stack)
Questions about this lesson?
Where this comes back
- Price multiples, enterprise value and asset-based valuation Equity Valuation: Concepts and Basic Tools
- Bond Valuation: Prices and Yields Fixed Income
Questions candidates ask
How do you calculate a two-stage dividend discount model?
Discount each high-growth dividend. Then compute the Gordon value at the end of the high-growth phase using the next year's dividend, discount it back n years and add the two parts.
When do you use a multistage DDM?
When a company's current growth is unsustainably high, or temporarily abnormal, and expected to move to a stable long-run rate.
Why is the terminal value so large?
It captures every dividend from the end of the forecast period to infinity, which is most of a growth company's worth.
Spotted an error? Tell us and we will fix it.