Gordon Growth Model
Gordon Growth Model is the method which use to calculate stock’s intrinsic value without the consideration of current market value. The value depends on the present value of stock future dividends which we expect to receive in the future. The dividend expects to grow at a certain rate base on past experience.
We can use the result from the Gordon Growth Model to compare with other companies in the industry. It allows us to benchmark between
Gordon Growth Model Formula
Stock Value = D1 / (k-g)
- D1: Expected Dividend for next year
- k : Rate of return
- g : Expected dividend growth rate
Gordon Growth Model Example
Company A listed in the US stock market. The company expects to pay dividend $ 5 per share for next year and it is expected to grow at 8%. The current price of Company A’s share is $ 300. Rate of return equal to 10%. Please calculate share intrinsic value using the Gordon Growth Model and compare it with the current price.
Share intrinsic value = $ 5 / (10% – 8%) = $ 250
It means that the current market value is higher than the intrinsic value.
Basic Assumption of Gordon Growth Model
In order to use the Gordon Growth Model, we have to make some assumptions such as:
- The company operation is not changed significantly
- The company growth at a constant rate
- There is enough cash to pay a dividend for an investor on a regular basic
Important of Gordon Growth Model
This method is widely used to calculate intrinsic value and estimate the share price. It is easy to understand as it shows the relationship between dividend, growth rate, and rate of return. It excludes the market value as it is subject to be manipulated by the other parties.
Limitation of Gordon Growth Model
This method excludes other factors such as brand loyalty, goodwill, and other intangible assets. These are the factors that have a significant impact on the share price. Moreover, Gordon Growth Model assumes that the dividend will grow at a stable rate which is not the case for real life.