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Gordon Growth Model Overview and Formula

Gordon's Growth Model (GGM) is a formula used to determine the intrinsic value of a stock based on future dividends expected to grow at a constant rate, helping investors assess if stocks are overvalued or undervalued. The model includes three key elements: Dividends Per Share (D1), growth rate in dividends (g), and the required rate of return (ke). However, it has limitations such as assuming constant growth, which may not hold true for all companies, and it does not account for non-dividend factors affecting stock value.

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Siddhartha Sharma 52
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102 views2 pages

Gordon Growth Model Overview and Formula

Gordon's Growth Model (GGM) is a formula used to determine the intrinsic value of a stock based on future dividends expected to grow at a constant rate, helping investors assess if stocks are overvalued or undervalued. The model includes three key elements: Dividends Per Share (D1), growth rate in dividends (g), and the required rate of return (ke). However, it has limitations such as assuming constant growth, which may not hold true for all companies, and it does not account for non-dividend factors affecting stock value.

Uploaded by

Siddhartha Sharma 52
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd

Gordon’

Gordon’s sGrowth
GrowthModel
Model(GGM):-
(GGM):-
Gordon’s Growth Model is a formula that helps in deriving “Intrinsic Value of a
Gordon’s Growth Model is a formula that helps in deriving “Intrinsic Value of a
stock” based on the future series dividends that is assumed to grow at a
stock” based on the future series dividends that is assumed to grow at a
constant rate. Thus, the resultant tells investors whether the stocks are
constant rate. Thus, the resultant tells investors whether the stocks are
“overvalued or undervalued”.
“overvalued or undervalued”.
Formula :- Elements:-
Elements:-
Formula :- GGM formula has three elements, which include:-
GGM formula has three elements, which include:-
• Dividends Per Share (D1) :- It is annual payment that
Value of Stock:- D1 • Dividends Per Share (D1) :- It is annual payment that
Value of Stock :- D1 companies payout to their Equity Shareholders.
(k - g) companies payout to their Equity Shareholders.
• Growth rate in DPS (g):- It shows the rate at which the
(k - g) • Growth rate in DPS (g):- It shows the rate at which the
Dividend Payout increases from one year to another.
Dividend Payout increases from one year to another.
• Required rate of Return (ke):- It is the minimum rate of
• Required rate of Return (ke):- It is the minimum rate of
return that the investors re ready to accept when they
return that the investors re ready to accept when they
buy a stock of a company. It is also known as Cost of
buy a stock of a company. It is also known as Cost of
Equity i.e.(ke).
Equity i.e.(ke).
Assumptions:- Drawbacks:-
• The life of the company is • The assumption of constant growth rate is the main
indefinite. limitation of the model. A company has high rate of
• It assumes that a company growth in early stage and it tend to decrease by the
grow at a constant rate. time it becomes mature.
• The company has stable • This model gives negative value in cases, when the
financial leverage or no required rate of return (ke) is less than the growth
financial leverage involved in rate of the company; thus the model is ineffective in
the company. such cases.
• The rate of return i.e. (ke) is • The model doesn’t account for non dividend-paying
constant. factors like the company size, brand value, market
• The Company free cash flow perception and condition. All these factors affect the
is paid as dividend at actual stock value ;hence the model doesn’t provide
constant growth rate. holistic picture of intrinsic value of company.
• The required rate of return is • The model can’t be used for companies with irregular
greater than the growth rate. cash flows, dividend patterns or financial leverage.

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