Definition
Both Discounted Cash Flow (DCF) and the Dividend Discount Model (DDM) estimate intrinsic value by discounting future cash returns to today's dollars. The difference is what they discount: DCF uses free cash flow to the firm; DDM uses dividends paid to shareholders.
Side-by-side comparison
| DCF | DDM | |
|---|---|---|
| What it discounts | Free cash flow (cash left after running and reinvesting in the business) | Dividends (cash actually paid to shareholders) |
| Discount rate | WACC (weighted cost of debt + equity) | Cost of equity only (no debt component) |
| Best for | Most companies — any business generating free cash flow | Banks, insurers, mature dividend payers |
| Fails when | FCF is negative or structurally unreliable (banks, REITs) | No dividend, or dividend is irregular/unsustainable |
| Terminal value | FCF growing forever at a terminal rate | Dividends growing forever (Gordon Growth Model) |
| Output | Enterprise value → subtract net debt → equity value per share | Equity value per share directly |
Which method should you use?
Does the company pay a stable, growing dividend?
Yes → DDM is viable
No → Use DCF
Is it a bank or insurer?
Yes → DDM (FCF is structurally unreliable for financials)
No → Continue
Is it a REIT?
Yes → Neither — use FFO/AFFO multiples
No → Continue
Is FCF positive and meaningful?
Yes → DCF
No → Growth model (EV/Sales) or normalised FCF
Formulas
DCF formula
Equity Value = Σ [ FCFₜ ÷ (1 + WACC)ᵗ ] + Terminal Value − Net Debt
DDM formula (Gordon Growth)
Equity Value = D₁ ÷ (Ke − g)
Worked example
Same company, two methods: Commonwealth Bank (CBA.AX)
CBA pays a stable $4.65/share dividend (96% payout ratio)
DDM: D₁ = $4.79, Ke = 10.1%, g = 3% → Intrinsic Value$67.46
DCF: Won't work — bank deposits aren't "free cash flow"N/A
For a bank like CBA, DDM is the right model. FCF-based DCF would mix up deposit inflows with operating cash, producing a meaningless number. KashVector's DCF tool auto-detects banks and switches to DDM.