This movie/ video describes the application of the Dividend Discount Model (DDM) to valuate common stocks. Please refer to the basics (Valuation of Preferred Stock) first. The following is a part of the transcript. This video requires Flash 8 or above.

We already mentioned that DDM is nothing but calculating the present value of the future dividends a share holder going to receive. It is again very important to clarify the cash flow amount, timing and discount rate relevant to the stock. For preferred stock, the cash flow is almost deterministic and it is also much easier to determine the discount rate (e.g. we can set it to be similar to or lower than that of the highest grade bond of the company).

To valuate a common stock, the concept is the same. However, it is more difficult. It is because, first, the dividend payout is not certain and, second, the required rate of return is more difficult to determine.

So, since this is just another cash flow and present value problem, we definition can use the sum we used for preferred stock, but change the D’s to individual values (D1, D2…)

D1/(1+k) + D2/(1+k)^2 + D3/(1+k)^3+…+D10000/(1+k)^10000+…

where k is the appropriate discount rate.

This change takes into the account that the dividend to be received is, unlike in preferred stock, not constant.

So again we are not going to find the price by calculating infinite number of terms. We will first look into another simplified situation, where Dn’s are related. In this situation, we assume the company is growing at constant rate and assume the dividend to be paid is also growing at constant rate (g% annually), the equation becomes:

D0*(1+g)/(1+k) + D0((1+g)/(1+k))^2 + D0((1+g)/(1+k))^3+…+D0*((1+g)/(1+k))^10000+…

Again, this is a geometric series and the sum can be simplified into

P = D0 * (1+g) / (k-g) = D1 / (k-g)

Please see the videos for details.