Gordon Growth Model

The Gordon Growth Model (GGM) is a simple way to value a stock based on its future dividend payments. It assumes that a company's dividends will grow at a constant rate forever.

Formula for Gordon Growth Model

P= D1 / (r−g)

Where:

• P = Intrinsic value of the stock
• D₁ = Expected dividend for the next year (D₀ × (1 + g))
• r = Required rate of return (cost of equity)
• g = Constant dividend growth rate

How to Use It?

To find the fair price of a stock, you need:
1.The company's expected dividend (D₁)
2.The growth rate of dividends (g)
3.The investor’s required return (r)

Example
A company pays a current dividend (D₀) of ₹5 per share, expects it to grow at 4% per year, and has a required return of 10%.

P = 5(1.04) /(0.10−0.04)

= 5.2 / 0.06

= Rs. 86.67

So, the fair value of the stock is ₹86.67 per share.

When is GGM Useful?

For valuing stocks of companies that pay stable, growing dividends (like blue- chip stocks).
When dividends are the main source of returns for investors.

Limitations of GGM

Doesn't work if g ≥ r (growth can't be higher than return).
Not useful for companies that don’t pay dividends.
Assumes constant dividend growth, which may not be realistic.

Alternatives to GGM

• Discounted Cash Flow (DCF) – Uses cash flows instead of dividends.
• Dividend Discount Model (DDM) – A more general version of GGM.
• Price/Earnings (P/E) Ratio – Valuation based on earnings instead of dividends.

Conclusion

The Gordon Growth Model (GGM) is a simple yet effective tool for valuing stocks based on their future dividends. It helps investors estimate the fair price of a stock, assuming a stable dividend growth rate. While GGM works well for companies with consistent dividend payouts, it has limitations when applied to high-growth or non-dividend-paying firms. Investors should use it alongside other valuation methods, such as the Discounted Cash Flow (DCF) model or P/E ratio analysis, for a more comprehensive investment decision.