How to Value a Forever Business? The Gordon Growth Model Explained
When looking for the “holy grail” of investing, most people search for one thing. Intrinsic Value.
How do you know if a stock is actually worth what the market says it is?
While there are many complex valuation methods, the most searched-for and widely used framework is the Gordon Growth Model (GGM).
Whether you are a finance student or a curious investor, understanding this constant growth model is essential for long-term equity analysis.
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What Is the Gordon Growth Model (GGM)?
The Gordon Growth Model is a valuation formula used to estimate the fair value of a stock by assuming that its dividends grow at a constant rate forever.
In simple terms, it treats a stock like a perpetual cash-generating machine that pays dividends every year, growing steadily over time.
The Formula. Breaking Down the Math
The beauty of the GGM lies in its simplicity. You only need three inputs.
D₁ (Expected Dividend)
The dividend you expect to receive next year.r (Cost of Equity)
The rate of return you require for the risk you are taking.g (Growth Rate)
The constant rate at which dividends are expected to grow forever.
Gordon Growth Model Formula
Lessons from the World’s Oldest Hotel
To see this model in action, consider Company ABC,a hypothetical firm designed to represent a business with infinite longevity and stable operations.
If we were to value Company ABC today, assuming it will continue to pay out dividends into the distant future, we could assume:
Expected dividend next year (D₁) = 1.02
Cost of equity (r) = 8%
Constant growth rate (g) = 2%
Instead of manually calculating dividends for hundreds of years, the Gordon Growth Model gives us the value instantly.
Calculation
Why This Matters to You as an Investor
The Gordon Growth Model proves one powerful idea.
The value of any stock is simply the present value of all future dividends.
Even if you plan to sell the stock next year, the price you receive from the next buyer is based on their estimate of the dividends they will receive after you are gone.
In other words, prices may change. Ownership may change.
But dividends are the foundation of value.
Pro Tip. A Critical Condition
For the Gordon Growth Model to work:
[r > g]
The required return must always be greater than the growth rate.
If a company grew faster than the economy forever, it would eventually become the entire world economy, which is clearly impossible.
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