14.8: What About Quarterly Dividends?

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No doubt you have noticed that the Dividend Discount Model, as so far presented, assumed that dividends are paid annually. We all know that companies pay dividends in quarterly payments. Does this difference in payment frequency matter? Should we not employ the DDM using quarterly payments? If dividends are paid quarterly, most of the funds will arrive sooner. Is it not a basic principle of the Time Value of Money that if the funds come in sooner the present value is greater, and isn’t a stock’s price present value? Ought that not affect the way we write the formula?

To adjust for this, we modify the formula and arrive at the following, using the simpler no-growth version:

Price = (D / 4) ÷ [(1 + R)^1/4– 1]

To illustrate this, we shall assume that:

D = $1

R = 0.10

When we calculate based on annual dividends, we get:

P + D / R

P = 1 ÷ 0.10 = $10

When we calculate based on quarterly dividends, we get:

P = (D / 4) ÷ [(1 + R)^1/4–1]

P = (1 / 4) ÷ [(1.10)^1/4–1] = $10.37

This value is substantially higher!

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