Gordon Growth Model
A stock valuation model that values a stock as the present value of future dividends growing at a constant rate, calculated as D/(r-g) where D is dividend, r is required return, and g is growth rate.
Example
“With a $2 dividend, 10% required return, and 3% growth rate, the Gordon Growth Model valued the stock at $28.57.”
Memory Tip
GORDON GROWTH MODEL = D / (r - g). Dividend divided by the difference between required return and growth.
Why It Matters
The Gordon Growth Model helps individual investors determine if a stock is fairly priced by calculating what dividends should theoretically be worth today. Understanding this model enables you to make more informed decisions about which dividend-paying stocks offer good value and whether a stock price is reasonable compared to its expected future cash flows.
Common Misconception
Many people assume the Gordon Growth Model works for all stocks, but it only applies to companies that pay consistent dividends and have stable, predictable growth rates. Using this model on startups, non-dividend-paying companies, or rapidly changing businesses will produce meaningless or misleading valuations.
In Practice
Suppose a company pays a quarterly dividend of $2 annually, investors require a 10 percent return, and the dividend is expected to grow at 3 percent per year. The fair value would be $2 divided by (0.10 minus 0.03), equaling approximately $28.57 per share. If the stock trades at $20, it may be undervalued; if it trades at $35, it may be overvalued.
Etymology
Developed by Myron J. Gordon in 1956. Also called the Dividend Discount Model.
Common Misspellings
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See Also
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