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Gordon Growth Model

Posted on October 16, 2025 by user

Gordon Growth Model

The Gordon Growth Model (GGM) is a dividend-discount valuation method that estimates a stock’s intrinsic value by assuming dividends grow at a constant rate forever. It’s a simple, widely used tool best suited for companies with stable, predictable dividend policies.

The formula

P = D1 / (r − g)

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Where:
* P = intrinsic value (current stock price)
* D1 = dividend expected next year
* r = required rate of return (cost of equity)
* g = constant perpetual growth rate of dividends

If only the most recent dividend D0 is available, use D1 = D0 × (1 + g).

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Important condition: r must be greater than g. If r ≤ g, the model is invalid (value becomes infinite or negative).

Why it matters

GGM converts an infinite stream of growing dividends into a present value. If the model’s P is higher than the market price, the stock may be undervalued; if lower, it may be overvalued. The model isolates dividend-driven intrinsic value independent of short-term market noise.

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Key assumptions

  • Dividends grow at a constant rate forever.
  • The company exists indefinitely and continues paying dividends.
  • The required rate of return (r) is constant.
  • The model applies only to dividend-paying firms with stable growth.

Inputs and how to estimate them

  • D1 (next year’s dividend): based on announced dividends or last paid dividend grown by expected g.
  • g (growth rate): often estimated from historical dividend growth, earnings growth, or analyst forecasts. Must be realistic and sustainable.
  • r (required return): can be estimated using models such as CAPM, or by using investor’s target return.

Example

Assume:
* D1 = $3
* r = 8% (0.08)
* g = 5% (0.05)

P = 3 / (0.08 − 0.05) = $100

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If the stock trades at $110, the model suggests it is $10 overvalued.

Strengths

  • Simple and intuitive.
  • Useful for quick valuations of mature, dividend-paying companies.
  • Facilitates comparison across dividend-paying firms.

Limitations and cautions

  • Relies on the strong assumption of constant, perpetual dividend growth — rarely true for most firms.
  • Sensitive to small changes in r and g; estimation errors can produce large valuation swings.
  • Not suitable for non-dividend or high-growth companies that reinvest earnings.
  • Invalid if r ≤ g.

Practical tips

  • Use GGM for mature firms with consistent dividend policies (utilities, consumer staples).
  • Cross-check g against long-term GDP or industry growth to ensure plausibility.
  • Perform sensitivity analysis across a range of r and g values.
  • For firms with non-constant dividend stages, consider multi-stage dividend-discount models instead.

Conclusion

The Gordon Growth Model is a compact, useful tool for valuing stable, dividend-paying companies. Its simplicity is an advantage, but its restrictive assumptions mean it should be applied selectively and supplemented with sensitivity testing or alternative valuation methods when appropriate.

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