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I've calculated the Share Price of a fictional company both using the Dividend Discount Model (DDM) and the Earnings Recapitaliazation Model (ERM). However, the share prices differ significantly between the two methods. Does anyone know the reasons why the results differ? Which method is preferable / which of the two result is correct?

Information about the company:

  • Dividend today: $5

  • Dividend growth rate: 3%

  • EPS today: 2$

  • EPS growth rate 3%

  • Cost of Capital: 8%

The results are (calculated with the perpetuity formula):

  • Share price with DDM: $108 -> (5*(1+3%))/(8%-3%)

  • Share price with ECM: $41.2 -> (2*(1+3%))/(8%-3%)

Thank you, Peter

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Your setup is flawed. Set growth to 0. How can a company pay 5 dollars in perpetuity when it only earns 2 in perpetuity? Add back in growth. How can a company pay 5 dollars growing at 3% in perpetuity when it only earns 2 growing at 3% in perpetuity?

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  • $\begingroup$ Thank you for your answer! If I understood it correctly, the problem is that the stated dividends are higher than the stated EPS, correct? Is it possible to say which valuation model is correct and which is wrong? Or is there a rule on which valuation model to use (ERM or DDM) in cases of contradicting values? $\endgroup$ – Peter May 17 at 13:34
  • $\begingroup$ The capitalized earnings method is wrong. It should be adjusted to be equivalent to the DDM by including dividends. Look at Ohlson’s Abnormal Earnings Growth model for the fix. $\endgroup$ – Mild_Thornberry May 17 at 13:39

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