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Constant Growth Model Formula:
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The Constant Growth Model, also known as the Gordon Growth Model, is a method for valuing a stock by assuming a constant growth rate in dividends per share. It calculates the intrinsic value of a stock based on its future dividend payments.
The calculator uses the Constant Growth Model formula:
Where:
Explanation: The model assumes that dividends will continue to grow at a constant rate indefinitely, and discounts those future dividends back to their present value.
Details: This model is widely used in finance for stock valuation, particularly for companies with stable dividend growth rates. It helps investors determine whether a stock is overvalued or undervalued based on its current price.
Tips: Enter the expected dividend in currency, required rate of return as a percentage, and the constant growth rate as a percentage. Ensure the required rate is greater than the growth rate for valid results.
Q1: What is the main limitation of the constant growth model?
A: The model assumes a constant growth rate forever, which may not be realistic for many companies, especially those in volatile industries.
Q2: Can this model be used for companies that don't pay dividends?
A: No, this model specifically requires dividend payments. For non-dividend paying companies, other valuation methods like discounted cash flow are more appropriate.
Q3: What happens if the growth rate exceeds the required rate?
A: The model breaks down mathematically and produces a negative value, which is not meaningful. This highlights the importance of realistic growth assumptions.
Q4: How sensitive is the model to changes in inputs?
A: The model is highly sensitive to changes in the growth rate and required return, as small changes in these percentages can significantly affect the calculated value.
Q5: What time period should the dividend represent?
A: Typically, the dividend used is the expected dividend for the next period (usually next year), not the most recent historical dividend.