Stock Valuation Calculator (Gordon Growth Model)
Use this calculator to estimate the intrinsic value of a stock based on its expected future dividends, required rate of return, and dividend growth rate.
Calculated Intrinsic Stock Value:
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Estimating the intrinsic value of a stock is a fundamental practice for investors looking to make informed decisions. While market prices fluctuate daily, intrinsic value represents what an asset is truly worth based on its underlying financial characteristics. One popular method for valuing dividend-paying stocks is the Gordon Growth Model (GGM), a variation of the Dividend Discount Model (DDM).
What is the Gordon Growth Model?
The Gordon Growth Model is a quantitative formula used to determine the fair value of a stock, assuming that dividends grow at a constant rate indefinitely. It's particularly useful for valuing mature companies with a stable history of dividend payments and predictable growth.
The Formula
The Gordon Growth Model formula is:
P0 = D1 / (r - g)
- P0: The current intrinsic value of the stock.
- D1: The expected dividend per share for the next year. This is crucial as it's a forward-looking estimate.
- r: The investor's required rate of return, also known as the cost of equity. This is the minimum return an investor expects to receive for taking on the risk of owning the stock.
- g: The constant growth rate in dividends expected for the company's dividends, assumed to continue indefinitely.
How to Use the Calculator
Our Stock Valuation Calculator simplifies the application of the Gordon Growth Model. Here's what each input means:
- Expected Next Year's Dividend per Share: Enter the dividend amount you anticipate the company will pay per share over the next 12 months. If the current year's dividend is known, you might estimate D1 by multiplying the current dividend by (1 + g).
- Required Rate of Return (as %): This is your personal hurdle rate or the return you demand from this investment. It often reflects the risk-free rate plus a risk premium, or the company's cost of equity. Enter it as a percentage (e.g., 10 for 10%).
- Expected Dividend Growth Rate (as %): Input the constant rate at which you expect the company's dividends to grow each year into perpetuity. This can be estimated from historical growth rates, industry averages, or analyst forecasts. Enter it as a percentage (e.g., 5 for 5%).
Important Considerations and Limitations
- Constant Growth Assumption: The GGM assumes dividends grow at a constant rate forever, which is rarely the case in reality. Companies often experience varying growth rates over different periods.
- Required Rate of Return > Growth Rate: A critical assumption is that the required rate of return (r) must be greater than the dividend growth rate (g). If r is less than or equal to g, the formula yields an infinite or negative stock price, indicating the model is not applicable or the growth rate is unsustainable.
- Dividend-Paying Stocks Only: This model is only suitable for companies that pay dividends. It cannot be used for non-dividend-paying stocks.
- Sensitivity to Inputs: The model is highly sensitive to changes in its inputs, especially the growth rate and required rate of return. Small adjustments can lead to significant changes in the calculated intrinsic value.
- Estimates: All inputs (D1, r, g) are estimates, and their accuracy directly impacts the reliability of the calculated intrinsic value.
Example Calculation
Let's say you are evaluating a company with the following characteristics:
- Expected Next Year's Dividend per Share (D1): $1.50
- Your Required Rate of Return (r): 10%
- Expected Dividend Growth Rate (g): 5%
Using the formula:
P0 = $1.50 / (0.10 - 0.05)
P0 = $1.50 / 0.05
P0 = $30.00
According to the Gordon Growth Model, the intrinsic value of this stock would be $30.00 per share. If the current market price is below $30.00, it might be considered undervalued, and if it's above, it might be overvalued, based on these assumptions.
While the Gordon Growth Model provides a useful framework for valuation, it's often used in conjunction with other valuation methods and qualitative analysis to arrive at a comprehensive investment decision.