Gordon Growth Model

Most finance students know that dividends matter. But very few understand... 👉 How can you estimate the intrinsic value of a stock using its future dividends? That's where the Gordon Growth Model comes in. So I created this one-page note to simplify: ✔️ What the Gordon Growth Model is ✔️ The intuition behind the formula ✔️ The key assumptions ✔️ A simple numerical example ✔️ When the model works—and when it doesn't The biggest realization for me was: > A stock's value today is simply the present value of all its future dividends, assuming they grow at a constant rate forever. Imagine a company that pays a dividend every year... and those dividends are expected to grow steadily over time. Instead of guessing what the stock is worth... the Gordon Growth Model helps estimate its intrinsic value using just three key inputs: • Expected Dividend • Required Rate of Return • Growth Rate One insight many finance students miss: 📌 The model is extremely sensitive to the growth rate (g) and the required return (r). Even a small change in either assumption can lead to a significant change in the estimated value. That's why the Gordon Growth Model is best suited for mature, stable companies with predictable dividend growth—not high-growth companies that don't pay regular dividends. This concept is fundamental to: • CFA Program • Equity Valuation • Corporate Finance • Equity Research • Investment Banking • Fundamental Analysis Once you understand the intuition... you stop treating stock valuation as just a formula. And start understanding how dividends, growth, and investor expectations come together to determine value. Because in valuation: ➡️ Higher expected dividends increase value. ➡️ Higher growth increases value. ➡️ Higher required return decreases value. ➡️ Small changes in assumptions can have a big impact on intrinsic value. Which valuation topic should I simplify next? #Finance #GordonGrowthModel #DividendDiscountModel #InvestmentBanking #CFA #CFALevel1 #CFALevel2

🌟 Day 94/174 – CFA Level 1 Preparation 💼 Today’s journey into Equity Valuation was nothing short of insightful! 📊 I focused on the Gordon Growth Model (GGM)—a cornerstone of stock valuation techniques that shines when a company enters its maturity phase with a constant long-term growth rate. 🌱 This model helps us determine whether a stock is undervalued or overvalued by comparing its Intrinsic Value (IV) with its Market Price (MP). 📘 The Gordon Growth Model Formula The formula for calculating a stock's intrinsic value is as follows: V₀ = D₁ / (Rₑ - g) Where: V₀: Intrinsic value of the stock 📈 D₀: Last dividend paid (current dividend) 💵 D₁: Expected or future dividend (dividend payable) 🔮 Rₑ: Required rate of return (%) 📊 g: Constant growth rate (%) 🌱 This formula becomes particularly powerful when dividends are expected to grow indefinitely at a constant rate, which is a key assumption of the GGM. --- 🧩 Real-Life Example: Buy or Pass? Let’s break it down with a practical example: 🔍 Scenario: Expected dividend (D₁): $2.50 Required rate of return (Rₑ): 15% Growth rate (g): 8% Market price (MP): $27 Using the formula: V₀ = D₁ / (Rₑ - g) = $2.50 / (0.15 - 0.08) = $2.50 / 0.07 = $35.71 The intrinsic value ($35.71) is greater than the market price ($27), which means the stock is undervalued. Hence, the decision is clear: Buy the stock! 💰 --- 🌟 Why Is the Gordon Growth Model Important? The GGM is one of the simplest and most effective tools for stock valuation in finance. Here’s why it stands out: 1️⃣ Ease of Use: With only three variables—dividends, growth rate, and required rate of return—you can quickly assess the intrinsic value of a stock. 2️⃣ Focus on Dividends: It prioritizes dividends, which are a tangible indicator of a company’s ability to generate and distribute earnings. 3️⃣ Applicability: Perfect for mature companies with stable and predictable growth rates (e.g., utility companies, established blue-chip firms). 4️⃣ Investment Decisions: It aids in answering one of the most critical questions for investors: Should I buy or pass? --- 💡 Key Insights Gained 🔑 Intrinsic Value vs. Market Price: When IV > MP, the stock is undervalued—an attractive buy opportunity. Conversely, when IV < MP, the stock may be overvalued and worth avoiding. 🔑 The Role of Assumptions: The accuracy of the GGM depends on how well you estimate growth rates, required return, and future dividends. Small changes in assumptions can lead to significant shifts in valuation. 🔑 Limitations to Consider: While the GGM is excellent for stable growth firms, it may not work as well for companies with fluctuating dividends or irregular growth rates (e.g., startups or cyclical industries). --- #CFA

What is Gordon's Growth Model? Let's Understand it. Gordon's Growth Model is a method to determine the intrinsic value of a stock based on a series of future dividends that grow at a constant rate. The formula is: P = D1 / (r−g) Where: P = Price of Intrinsic Value of the stock D1 = Dividend expected next year r = Required rate of return g = Growth rate of dividends ♦ Key Assumptions • Constant Growth Rate: Dividends are expected to grow at a constant rate indefinitely. • Stable Required Return: The required rate of return remains stable over time. • Perpetual Dividends: The company is assumed to continue paying dividends forever. ♦ Example Let's say we have a company, XYZ Corp, with the following characteristics: Expected dividend next year (D1): $2 Required rate of return (r): 8% or 0.08 Constant growth rate of dividends (g): 4% or 0.04 P = 2 / (0.08 − 0.04) = 2 / 0.04 = 50 So, the intrinsic value of XYZ Corp's stock is $50. ♦ Pros and Cons Pros • Simplicity: Easy to understand and apply. • Focus on Dividends: Aligns with a value-investing philosophy that dividends reflect a company's financial health. • Long-Term Perspective: Suitable for stable companies with predictable dividend growth. Cons • Assumption Sensitivity: Small changes in r or g can significantly impact the valuation. • Applicability: Not suitable for companies that do not pay dividends or have highly variable dividend growth. • Constant Growth Rate: The model assumes a perpetual and constant growth rate, which is unrealistic for many firms. ♦ Use Cases • Mature, Dividend-Paying Companies: Investors use Gordon's Growth Model to value stocks of mature companies with a history of paying and increasing dividends. • Valuation Benchmarking: The model provides a benchmark to compare the intrinsic value with the current market price to identify undervalued or overvalued stocks. #linkedin #finance #investment Parth Verma

While brushing up on my CFA Concepts, I decided to why not delve a little further into practicality... I made a valuation model on the third-largest tele-communication company (by revenue) - AT&T (NYSE: Ticker "T") Using the Dividend Discount Model (DDM) approach, I considered finding the intrinsic value of AT&T, given its relatively stable dividend payments every year. First step was finding the sustainable growth rate for dividends (g) using the historical dividend payout provided in their Investor Relation website from 1984 till 2025. One could argue I should have chosen a shorter time period, say after 2008, because of regime change. This will be referred to after extensive research that which timeline should be used, along with a multi-period DDM model. For this, I chose 3 scenarios - Best, Base, and Worst, and conducted scenario analysis using these 3 growth rates. Next step was using CAPM = Rf + (Rm - Rf) Beta, to find out the Cost of Equity. For this, I used the 10-year US Treasury Bond Yield as the risk-free rate and the S&P 500 10-year annualised rate for Market Return. Since this was a short project, I didn't use the Fama and French Five Factor Model. Once I got my inputs, I used the Gordon Growth Model (GGM) to find out the intrinsic value of AT&T, and comparing it with the current market price, I could see it was overvalued. Result (summary): In my base case, the model suggests an intrinsic value that is $9.1136 below the market price, indicating the stock is currently priced at a premium to the dividend-driven intrinsic estimate. However, this might also be because it was a very simple valuation model, and it doesn't take into consideration the current geopolitical struggles and human tendency to buy safe stocks that provide stable dividends. Feel free to check it out below and share your own opinions and what practices you use to value your equity stocks. If you’re interested in the Excel behind this model, DM me or comment below and I’ll share it. Would love to hear: for telecoms, do you prefer using CAPM or a multi-factor approach for cost of equity? #Valuation #CFA #EquityResearch #FinancialModeling #Finance

Day 2 of 30: Making Formulas Simple. How do investors estimate what a stock is worth today based on the dividends it will pay in the future? That's where the Gordon Growth Model comes in. At its core, the formula assumes that a company will continue paying dividends that grow at a steady rate forever. Think about it this way: If a company pays you a dividend every year and that dividend keeps growing, those future cash flows have value today. The Gordon Growth Model helps us calculate that value. Why is it useful? ✅ Helps estimate the intrinsic value of dividend-paying stocks ✅ Widely used in equity research and valuation ✅ Simple yet powerful framework for long-term investors ✅ Shows how growth and required return impact stock prices One important takeaway: 📈 Higher dividend growth = Higher stock value 📉 Higher required return = Lower stock value While no valuation model is perfect, the Gordon Growth Model provides a great starting point for understanding how investors think about stock valuation. Finance doesn't have to be complicated. One formula at a time, we'll make it simple. What valuation formula should I cover next? Let me know below. #Finance #Investing #StockMarket #EquityResearch #Valuation #DividendInvesting #GordonGrowthModel #DDM #FinancialModeling #CorporateFinance #InvestmentAnalysis #ValueInvesting #FinancialEducation #FinanceMadeSimple #LearningInPublic #LinkedInCreators #WealthCreation #CFA #Business #Day2Of30