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Published On:Wednesday 11 January 2012
Posted by Muhammad Atif Saeed

Gordon Growth Model

A model for determining the intrinsic value of a stock, based on a future series of dividends that grow at a constant rate. Given a dividend per share that is payable in one year, and the assumption that the dividend grows at a constant rate in perpetuity, the model solves for the present value of the infinite series of future dividends.
Gordon Growth Model


Where:
D = Expected dividend per share one year from now
k = Required rate of return for equity investor
G = Growth rate in dividends (in perpetuity)

explains 'Gordon Growth Model'


The Gordon growth model is a type of dividend discount model used to value companies expected to grow at a constant rate forever. Most valuation models forecast growth for a certain time period before reverting to a Gordon growth model to estimate the ending value.

Because the model simplistically assumes a constant growth rate, it is generally only used for mature companies (or broad market indices) with low to moderate growth rates.

Strengths:
  • Especially useful for valuing stable-growth dividend paying companies
  • Useful for valuing broad-based equity indices
  • Simplicity and clarity
  • Helpful in understanding relationships between value, growth, required return and payout ratio
  • Useful for estimating expected rate of return
Weaknesses:
  • Output highly sensitive to assumptions for growth rate and required return
  • Not practical for valuing non-dividend paying companies
  • Not practical for valuing dividend paying stocks with unstable growth characteristics

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Posted by Muhammad Atif Saeed on 20:34. Filed under , , . You can follow any responses to this entry through the RSS 2.0. Feel free to leave a response

By Muhammad Atif Saeed on 20:34. Filed under , , . Follow any responses to the RSS 2.0. Leave a response

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I am doing ACMA from Institute of Cost and Management Accountants Pakistan (Islamabad). Computer and Accounting are my favorite subjects contact Information: +923347787272 atifsaeedicmap@gmail.com atifsaeed_icmap@hotmail.com

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