What Is the Gordon Growth Model?

The Gordon Growth Model (GGM) is a formula used to calculate the intrinsic value of a stock based on its expected future dividends, assuming those dividends grow at a constant rate indefinitely. Also known as the constant growth dividend discount model, the GGM uses the formula P = D1 / (r – g), where P is the stock’s fair value, D1 is next year’s expected dividend, r is the required rate of return, and g is the constant dividend growth rate.

Developed by economist Myron Gordon in the 1950s, this model is one of the most widely taught stock valuation methods in finance. It is especially useful for valuing mature, dividend-paying companies with stable growth, such as utilities, consumer staples, and large-cap blue chips. Because it simplifies a company’s entire future cash flow stream into a single perpetuity calculation, the Gordon Growth Model serves as both a standalone valuation tool and the foundation for calculating terminal value in DCF valuation models.

In this guide, you will learn how to calculate stock value using the GGM formula, understand its key assumptions and limitations, see a worked numerical example, and discover when the Gordon Growth Model is the right valuation approach versus other methods.

How Does the Gordon Growth Model Formula Work?

The Gordon Growth Model expresses the value of a stock as a perpetuity of growing dividends. The formula is:

P = D1 / (r – g)

Where:

Variable	Meaning	Example
P	Intrinsic value (fair price) of the stock	The price you calculate
D1	Expected dividend per share one year from now	$2.50
r	Required rate of return (or cost of equity )	10% (0.10)
g	Constant annual dividend growth rate	4% (0.04)

Important: D1 is the next year’s dividend, not the current dividend. If you know the current dividend (D0), calculate D1 as:

D1 = D0 x (1 + g)

The formula works because it mathematically sums an infinite series of growing dividends, discounted back to their present value. As long as the growth rate (g) is less than the required return (r), this infinite series converges to a finite number, the stock’s intrinsic value.

Why Must r Be Greater Than g?

If the dividend growth rate equals or exceeds the required rate of return, the formula produces a negative or infinite result, which is economically meaningless. This is one of the model’s key constraints: it only works when the discount rate exceeds the growth rate (r > g). In practice, this means the GGM cannot value high-growth companies whose dividends are expected to grow faster than the investor’s required return.

Gordon Growth Model Example: Step-by-Step Calculation

Here is a worked example showing how to apply the Gordon Growth Model to value a stock.

Scenario: You are analyzing ABC Utilities Corp, a mature utility company. Here are the inputs:

• Current annual dividend (D0): $3.00 per share
• Expected dividend growth rate (g): 5% per year
• Your required rate of return (r): 12%

Step 1: Calculate D1 (Next Year’s Dividend)

D1 = D0 x (1 + g) D1 = $3.00 x (1 + 0.05) D1 = $3.00 x 1.05 D1 = $3.15

Step 2: Apply the Gordon Growth Model Formula

P = D1 / (r – g) P = $3.15 / (0.12 – 0.05) P = $3.15 / 0.07 P = $45.00

Step 3: Compare to Market Price

Comparison	Implication
Market price < $45.00	Stock is undervalued, potential buy
Market price = $45.00	Stock is fairly valued
Market price > $45.00	Stock is overvalued, potentially sell or avoid

If ABC Utilities trades at $38 per share, the GGM suggests the stock is undervalued by approximately 18%, which may represent a buying opportunity.

Sensitivity to Inputs

Small changes in the growth rate or required return produce large swings in valuation. Here is how the fair value changes when you adjust the inputs:

Growth Rate (g)	Required Return (r)	D1	Fair Value (P)
3%	12%	$3.09	$34.33
4%	12%	$3.12	$39.00
5%	12%	$3.15	$45.00
6%	12%	$3.18	$53.00
5%	10%	$3.15	$63.00
5%	14%	$3.15	$35.00

This sensitivity demonstrates why analysts must carefully estimate g and r. A 1-percentage-point change in growth rate can shift the valuation by 20% or more.

What Are the Assumptions of the Gordon Growth Model?

The Gordon Growth Model relies on several key assumptions that determine when it is valid and when it breaks down:

1. Constant dividend growth rate: The model assumes dividends grow at the same rate (g) forever. In reality, very few companies maintain truly constant growth over decades.
2. Company pays dividends: The GGM only works for dividend-paying stocks. It cannot value companies that reinvest all earnings (like many technology companies).
3. Growth rate is less than required return: The formula requires r > g. If a company’s dividends are growing faster than the discount rate, the model produces meaningless results.
4. Perpetual existence: The model assumes the company operates indefinitely. It does not account for bankruptcy risk, acquisition, or structural business changes.
5. Stable business model: Constant growth implies a mature company with predictable earnings, stable payout ratios, and limited disruption risk.

These assumptions make the GGM best suited for:

• Utilities with regulated, predictable cash flows
• Consumer staples companies with long dividend histories
• Large financial institutions with stable payout policies
• REITs with consistent distribution growth

It is poorly suited for startups, high-growth tech companies, cyclical businesses, or firms that do not pay dividends.

When Should You Use the Gordon Growth Model?

The Gordon Growth Model is most effective in specific valuation contexts. Understanding when to use it and when to choose a different method is essential for accurate analysis.

Use the GGM when:

• The company has a long history of paying and growing dividends (10+ years of consistent increases)
• Dividend growth has been relatively stable (no wild swings year to year)
• The company operates in a mature, low-growth industry (utilities, telecom, consumer staples)
• You need a quick intrinsic value estimate without building a full financial model
• You are calculating the terminal value as part of a larger DCF analysis

Choose a different method when:

• The company does not pay dividends, use a DCF model with free cash flow instead
• Dividends are growing rapidly or erratically, so use a multi-stage dividend discount model
• The company is in a cyclical industry, and the constant growth assumption will not hold
• You need to value a pre-revenue or early-stage company, use comparable company analysis, or venture capital methods

For guidance on which valuation method is most suitable for different types of companies, matching the right model to the right business is a core skill in professional valuation.

Gordon Growth Model vs. DCF: What Is the Difference?

The Gordon Growth Model and the discounted cash flow (DCF) model are closely related but serve different purposes. In fact, the GGM is technically a simplified special case of DCF analysis.

Feature	Gordon Growth Model (GGM)	Full DCF Model
Cash flow used	Dividends only	Free cash flow to firm (FCFF) or equity (FCFE)
Growth assumption	Single constant rate forever	Different rates for the forecast period + terminal period
Complexity	Simple, one formula	Complex, requires full financial projections
Best for	Stable, dividend-paying companies	Any company with estimable cash flows
Inputs needed	D1, r, g	Revenue forecasts, margins, capex, WACC, terminal growth
Terminal value	The GGM IS the terminal value	Often uses GGM to calculate the terminal value
Accuracy	Lower (one growth rate oversimplifies)	Higher (captures changing growth phases)

DDM vs. FCFE: Which Approach Is Better?

The dividend discount model (DDM), of which the GGM is the simplest form, values equity by discounting dividends. The free cash flow to equity (FCFE) model values equity by discounting cash flows available to shareholders, whether or not those cash flows are actually paid as dividends.

Key differences:

• DDM is appropriate when dividends reflect the company’s actual distribution policy and growth trajectory
• FCFE is preferred when companies retain significant earnings, buy back shares, or have volatile payout ratios
• For most modern companies, FCFE provides a more comprehensive picture because it captures all cash flows to equity holders, not just dividends

In professional equity research, analysts often use both approaches as cross-checks. Aswath Damodaran’s approach to equity valuation emphasizes matching the valuation model to the company’s cash flow profile, a principle that helps analysts decide between DDM, FCFE, and FCFF approaches.

What Are the Limitations of the Gordon Growth Model?

While the Gordon Growth Model is elegant and easy to apply, it has significant limitations that practitioners must understand:

1. Unrealistic Constant Growth Assumption

No company grows dividends at the same rate forever. Economic cycles, competitive disruptions, regulatory changes, and management decisions all cause growth to fluctuate. The GGM cannot capture these dynamics.

2. Extreme Sensitivity to Inputs

As the sensitivity table above demonstrates, small changes in g or r produce large valuation swings. When g approaches r, the calculated value approaches infinity, a clearly unrealistic result. This makes the model unreliable when the spread between r and g is narrow.

3. Excludes Non-Dividend-Paying Companies

The GGM cannot value companies that reinvest all earnings. This excludes large portions of the market, including many technology, biotech, and high-growth companies.

4. Ignores Capital Gains Potential

The model values stocks purely on their dividend stream. It does not capture value from share buybacks, asset appreciation, or strategic transactions that create shareholder value outside the dividend channel.

5. No Risk Adjustment Beyond Discount Rate

All risk is captured in a single discount rate (r). The model does not explicitly account for industry-specific risks, liquidity risk, or tail events that could impact the company’s ability to maintain its dividend.

Common Mistakes When Using the Gordon Growth Model

Analysts frequently make these errors when applying the GGM. Understanding them will help you produce more accurate valuations:

Mistake 1: Using D0 Instead of D1

The formula requires D1 (next year’s dividend), not D0 (the most recent dividend). Forgetting to multiply D0 by (1 + g) will undervalue the stock.

Mistake 2: Setting Growth Rate Too High

Using a growth rate that exceeds the economy’s long-term growth rate (typically 2-4%) for a perpetuity model is unrealistic. Even great companies cannot outgrow GDP forever.

Mistake 3: Ignoring the r > g Constraint

When analyzing high-growth companies, students sometimes plug in growth rates that approach or exceed the required return. This produces absurdly high or negative valuations. If g is close to r, the GGM is the wrong model.

Mistake 4: Not Stress-Testing the Valuation

A single-point GGM estimate creates false precision. Always build a sensitivity table showing how the valuation changes across a range of growth rates and discount rates.

Mistake 5: Using GGM for the Wrong Companies

Applying the GGM to companies with erratic dividends, no dividend history, or high-growth profiles violates the model’s fundamental assumptions. Understanding which valuation method fits different company types is critical.

Frequently Asked Questions

What is the Gordon Growth Model formula?

The Gordon Growth Model formula is P = D1 / (r – g), where P is the stock’s intrinsic value, D1 is next year’s expected dividend per share, r is the required rate of return (or cost of equity), and g is the constant annual dividend growth rate. The formula values a stock as the present value of an infinite stream of dividends growing at a constant rate. It was developed by economist Myron Gordon and is also called the constant growth dividend discount model.

What is the constant growth model?

The constant growth model is another name for the Gordon Growth Model. It is called “constant growth” because it assumes dividends grow at the same fixed percentage rate every year into perpetuity. This distinguishes it from multi-stage dividend discount models, which allow for different growth rates during different periods. The constant growth model is the simplest form of the dividend discount model (DDM) and is most appropriate for mature, stable companies.

What is the difference between DDM and FCFE?

The dividend discount model (DDM) values a stock by discounting its expected future dividends, while the free cash flow to equity (FCFE) model discounts all cash flows available to shareholders, including retained earnings and buybacks, not just dividends. FCFE is more comprehensive because it captures shareholder value that is not distributed as dividends. DDM is better suited for companies with consistent payout policies. Analysts often use both as cross-checks in equity valuation.

How do you estimate the growth rate for the Gordon Growth Model?

Analysts estimate the dividend growth rate (g) using three common approaches: (1) historical dividend growth, averaging the rate at which dividends have increased over the past 5-10 years; (2) the sustainable growth rate formula: g = ROE x retention ratio, where retention ratio is 1 minus the payout ratio; (3) analyst consensus forecasts of long-term earnings growth. The chosen growth rate should not exceed the long-term nominal GDP growth rate (typically 2-4%) since no company can outgrow the economy indefinitely.

Can the Gordon Growth Model be used for the terminal value in DCF?

Yes. The Gordon Growth Model is one of the two standard methods for calculating terminal value in a DCF model. In this context, analysts replace dividends with free cash flow and apply a long-term perpetuity growth rate (typically 2-3%) to estimate the value of all cash flows beyond the explicit forecast period. The formula becomes Terminal Value = FCF(n+1) / (WACC – g). This approach is called the perpetuity growth method and complements the terminal multiplier approach.

Where can I learn DCF valuation online?

Valuation Master Class offers a comprehensive online DCF valuation course taught by Dr. Andrew Stotz, a former number-one-ranked equity analyst. The program covers the Gordon Growth Model, multi-stage DDM, FCFE and FCFF models, financial statement analysis, and real-world company valuation projects. It is designed for finance professionals at every career stage, from starters building foundational skills to experienced analysts refining their methodology.