Wize University Introduction to Finance Textbook > Equity Valuation
Common Shares (Constant Growth) - Gordon Growth Model
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Growing Dividends
Gordon Growth Model (GGM) assumes that a company exists forever and that there is a constant growth in dividends when valuing a company's stock.
• Richer model of stock valuation.
• Suitable for stable growth companies
• Assumes a constant dividend growth rate in perpetuity
• Assumes company lives on forever
Formula breakdown:
D1 = Dividend in period 1
P0 = Price of Stock at time zero (today)
r = Risk-adjusted effective periodic rate (expected return)
g = Constant growth rate of dividends
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Example: Gordon Growth Model
ABC Inc. will pay a $2.00 dividend next year and the company is expected to grow by 4% per year. Determine the price of a share in ABC Inc. today if investors have a required rate of return of 8%.
Mark Yourself Question
- Grab a piece of paper and try this problem yourself.
- When you're done, check the "I have answered this question" box below.
- View the solution and report whether you got it right or wrong.
Practice: Gordon Growth Model
White Rock Water sells water bottles to Asia. White Rock Water pays an annual dividend of $2.30 (just paid) that is expected to grow at 2% per annum—in line with the global economic growth rate. Your required rate of return is 6%.
Is the stock over-valued from your perspective if a share of White Rock Water is trading at $25.60?
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Example: Gordon Growth Model
ABC Inc. is growing at 8% per year. Its expected dividend payment next year is $4. The company’s current share price is $85.
What is the company’s expected return?
Practice: Gordon Growth Model
Investors have been receiving a dividend from ABC Corp for years and in recent years the company has been increasing their dividend by 4% per year. This is expected to continue for the foreseeable future, and today the company paid its annual dividend of $3 per share and the shares are currently trading at $78 per share.
What is the required rate of return?
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Example: Gordon Growth Model
ABC Inc. just paid a $2 per share dividend and has announced it will decrease the amount it pays by 3% per year indefinitely as it has been having several financial issues in recent times. Investors require a return of 15% on the stock given its high risk.
What is the current price of the stock?
Practice: Gordon Growth Model
You just received your dividend from Happle Corporation, the dividend was $4 per share, a 5% decrease from the previous year. The company is expected to continue decreasing its annual dividends at this rate and the market's required rate of return on this stock is 10%.
How much can you sell the stock for today?