The dividend capitalization model, also known as the dividend growth model, is used to find the cost of equity.  To understand why the dividend capitalization model makes sense and is useful you must understand what influences the price of a stock.  And you must believe that the most important factor that influences the price of a stock is the future dividends that it’ll pay.

The calculation for the dividend capitalization model is as follows:

Cost of Equity = (Dividends per Share (for next year)/Current Market Value of Stock) + Growth Rate of Dividends

Dividends per share are reported in the company’s financial statements, and future ones are always disclosed in news releases.  The current market value of the stock can easily be obtained from places such as google.com/finance or finance.yahoo.com.  However, the growth rate of the dividends is an assumption estimation that you must make when valuing the company.  You can look up in the company’s annual reports the dividends that have been paid year by year by the company up to this point and figure out the growth rate.  This is a good strategy, but keep in mind that past results are not always implications of future results.  Another method would be to look at what the company’s management is prediciting for future dividend payment; remember though that management is often optimistic in their forecasts.  There is no perfect method, that’s why telling the future isn’t easy, even if Miss Cleo claims on her commercials that it is.

The dividend capitalization model is not the only model used for calcuating cost of equity.  The capital asset pricing model, CAPM, is also widely used and often more popular.  Both, however, can be used and often are for discounted cash flow anyalsis, DCF.