How do I value a firm transitioning from high growth to stable growth using the two-stage DDM?

Question

AcadiFi · Accepted Answer

The two-stage DDM sums the PV of high-growth dividends plus the PV of a terminal Gordon value at the end of stage 1: V₀ = Σ [Dt/(1+r)^t] for t=1 to N + [V_N/(1+r)^N], where V_N = D_{N+1}/(r−g_stable).

For Calidor Tech, D₀ = $1.50, g₁ = 18% (years 1-5), g₂ = 5% (years 6+), r = 11%:

Stage 1 dividends:
- D₁ = 1.50 × 1.18 = $1.77
- D₂ = 1.77 × 1.18 = $2.0886
- D₃ = 2.0886 × 1.18 = $2.4645
- D₄ = 2.4645 × 1.18 = $2.9081
- D₅ = 2.9081 × 1.18 = $3.4315

PV of stage 1 at r=11%:
- 1.77/1.11 = 1.5946
- 2.0886/1.11² = 1.6956
- 2.4645/1.11³ = 1.8023
- 2.9081/1.11⁴ = 1.9157
- 3.4315/1.11⁵ = 2.0368
- Total stage 1 PV = $9.045

Terminal value at end of year 5:
- D₆ = 3.4315 × 1.05 = $3.6031
- V₅ = 3.6031 / (0.11 − 0.05) = $60.05
- PV(V₅) = 60.05 / 1.11⁵ = $35.63

Fair value V₀ = $9.045 + $35.63 = $44.68

Key insight: the terminal value dominates (80% of V₀). Small changes in g_stable or r swing the answer substantially. Also check economic reasonableness — can Calidor really sustain 18% dividend growth for 5 years? That implies rapid earnings growth AND stable payout, which rarely both hold during high-growth phases (growth firms usually retain, not distribute).

How do I value a firm transitioning from high growth to stable growth using the two-stage DDM?

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