A financial model called the Gordon Growth Model, commonly referred to as the dividend discount model (DDM), determines a stock's intrinsic value based on anticipated future dividends. In the 1960s, Myron J. Gordon, a professor of finance at the University of Toronto, created the concept.
The Gordon Growth Model presupposes that a stock's price is equal to the total discounted present value of all future dividends it will pay. This rate, also referred to as the needed rate of return or discount rate, reflects the investor's anticipated return on investment in light of the stock's risk.
The Gordon Growth Model's equation is as follows:
PV = D / (r - g)
Where:
PV = present value of the stock
D = expected dividend per share
r = required rate of return or discount rate
g = expected dividend growth rate
The model assumes that the company will continue to pay dividends indefinitely and that the dividend will grow at a constant rate indefinitely as well. This assumption may not hold true for all companies, especially those in the technology industry that do not pay dividends or may change their dividend policies over time.
The Gordon Growth Model can be useful for valuing stocks that pay regular dividends and have a stable dividend growth rate. However, it is not always a reliable indicator of a stock's value. Other factors, such as market sentiment, macroeconomic conditions, and company-specific factors, can also influence the price of a stock.
Furthermore, the model relies heavily on the inputs used to calculate the required rate of return and the expected dividend growth rate. These inputs can be difficult to estimate accurately, and small changes in these values can have a significant impact on the calculated intrinsic value of the stock.
The Gordon Growth Model is a financial model used to calculate the intrinsic value of a stock based on its expected future dividends. The model assumes that the stock's price is equal to the present value of all future dividends it will pay, discounted at a constant rate. While the model can be useful for valuing certain types of stocks, it is not always a reliable indicator of a stock's value and should be used in conjunction with other valuation methods and factors.
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