Gordon Growth Model
Constant-growth dividend discount model: present value of an infinite stream of dividends growing at a constant rate g, discounted at required return r. The foundational dividend-based valuation formula.
When to use: Use for mature, stable dividend payers where growth is reasonably constant and r > g. Provides an intrinsic-value estimate driven entirely by dividend policy and discount rate.
Formula
Variables
| Symbol | Name | Description | Unit |
|---|---|---|---|
| V0 | Intrinsic Value | Per-share intrinsic value implied by the model | $ |
| D1 | Next-Year Dividend | Expected dividend per share next year | $ |
| r | Required Return | Annual required rate of return as a decimal | % |
| g | Earnings Growth Rate | Expected annual EPS growth as a decimal | % |
Real-Life Examples
Example 1: Dividend Stock at 8% Required Return
A stock pays $2.00 next year, dividends grow at 4% perpetually, required return 8%.
Given
Step-by-Step
Intrinsic value is $50 per share. If the stock trades below this, it is undervalued by the model; if above, overvalued. Sensitivity is high — a 100bp change in r or g shifts the value materially.
Frequently Asked Questions
The model breaks down — the present value diverges to infinity, which makes no economic sense. Constant growth equal to or exceeding the discount rate cannot persist; either growth is overestimated, the discount rate is underestimated, or the constant-growth assumption is wrong.
Extremely. Small changes in r − g (the spread, not the levels) cause large value swings because the spread appears in the denominator. A 1% spread (r − g = 1%) gives 100× the dividend; a 4% spread gives 25×. Always check sensitivity before relying on a single point estimate.
Because the model values cash flows at year-end, starting one period from now. If you have D0 (current annual dividend), use D1 = D0 × (1 + g) to get next year's expected dividend before applying the formula.