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# What is the Gordon Growth Model? ## Definition of the Gordon Growth Model

• The Gordon growth model, or GGM, is used to calculate the intrinsic value of a stock from future dividends.
• The model only works for companies that pay out dividends, which have a constant growth rate.

## What Impacts the Gordon Growth Model?

• The required rate of return
• Dividend
• Dividend growth rate

## How to Calculate the Gordon Growth Model?

• The intrinsic value of an equity is calculated by dividing the value of the next year’s dividend by rate of return less the growth rate.

P = D1/r – g

(Where P = current stock price, D1 = value of next year’s dividend, g = constant growth rate expected, and r = required rate of return.)

## Why is the Gordon Growth Model Important?

• Compared to other valuation methods, the Gordon growth model is much more straightforward to calculate.
• The Gordon growth model helps investors see whether the stocks are undervalued or overvalued.
• With this model, the investors would make a more rational choice when trading stocks.

## The Gordon Growth Model in Practice

• For example, if a company lists its stock price at \$50, has a required rate of return at 15% (r), pays a dividend of \$1 per share you own, and has a constant growth rate of 6% then how would you calculate the stock value?
• \$1 ÷ (0.15 – 0.06) = \$11.11
• The model would not be practical if the growth rate is equal or more than the required rate of return.
• It is almost impossible for firms to have a constant growth rate over a long period, which violates the assumptions of GGM.