What is the Gordon growth model

The Gordon Growth Model (GGM) is a formula used to determine the intrinsic value of a stock based on a future series of dividends growing at a constant rate. The GGM attempts to estimate the fair value of a stock regardless of prevailing market conditions and takes into consideration dividend payout factors and expected market returns. Let's see how to use Gordon's growth model to our advantage.

What is the Gordon growth model

The Gordon Growth Model (GGM) is a formula used to determine the intrinsic value of a stock based on a future series of dividends growing at a constant rate. It is a popular and simple variant of the dividend discount model (DDM). The GGM assumes that dividends grow at a constant rate in perpetuity and solves for the present value of the infinite series of future dividends. Because the model assumes a constant growth rate, it is generally only used for companies with stable growth rates in dividends per share.

What is Gordon's growth model for?

The GGM attempts to estimate the fair value of a stock regardless of prevailing market conditions and takes into consideration dividend payout factors and expected market returns. If the value obtained from the model is higher than the stock's current trading price, the stock is considered undervalued and qualifies for a buy, and vice versa. Dividends per share represent the annual payments a company makes to its common stock shareholders, while the dividend per share growth rate is how much the dividend per share rate increases from year to year. The required rate of return is the minimum rate of return that investors are willing to accept when purchasing shares of a company, and there are several models that investors use to estimate this rate.

Gordon Growth Model Formula

The Gordon growth model formula is based on the mathematical properties of an infinite series of numbers that grow at a constant rate. The three key inputs in the model are dividends per share (DPS), dividend per share growth rate, and required rate of return (ROR).

formula

Gordon growth model calculation formula.

Example of using the Gordon growth model

As a hypothetical example, let's think about a company whose stock is trading at $110 per share. This company requires a minimum rate of return of 8% (r) and will pay a dividend of $3 per share next year (D1), which is expected to increase by 5% annually (g). The intrinsic value (P) of the stock is calculated as follows:

According to Gordon's growth model, the stock is currently $10 overvalued by the market.


Leave a Comment

Your email address will not be published. Required fields are marked with *

*

*

  1. Responsible for the data: Miguel Ángel Gatón
  2. Purpose of the data: Control SPAM, comment management.
  3. Legitimation: Your consent
  4. Communication of the data: The data will not be communicated to third parties except by legal obligation.
  5. Data storage: Database hosted by Occentus Networks (EU)
  6. Rights: At any time you can limit, recover and delete your information.