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The Gordon Growth Model (GGM) calculates the intrinsic value of a stock by dividing next year's expected dividend by the difference between the required rate of return and the assumed constant dividend growth rate. The formula is: Stock Value = D1 / (r - g), where D1 is the next period's dividend per share, r is the required rate of return, and g is the constant dividend growth rate.
Economist Myron J. Gordon of the University of Toronto published the model with Eli Shapiro in 1956. The work built on John Burr Williams' 1938 dividend discount framework. The GGM is the simplest variant of the broader dividend discount model family.
Suppose a company pays a current dividend of $5.00 per share. The dividend grows at 4% per year indefinitely. Your required rate of return is 9%.
First, calculate D1: $5.00 × 1.04 = $5.20. Then divide by (r - g): $5.20 / (0.09 - 0.04) = $5.20 / 0.05 = $104.00. The model says the stock is worth $104.00 per share. If it trades at $90.00, the GGM signals undervaluation. If it trades at $120.00, it signals overvaluation.
You need three numbers to run the model. Getting any one wrong produces a meaningless result.
The GGM is undefined when g is equal to or greater than r. If both are 8%, the denominator is zero and the calculation produces an infinite stock price, which is mathematically meaningless. If g exceeds r, you get a negative value, which is equally useless.
This is not a quirk. It reflects a genuine economic constraint: no company can grow its dividends faster than the overall economy indefinitely. The CFA Institute's curriculum notes that the long-term sustainable growth rate for any company is anchored to the broader economy's real growth rate.
The GGM suits stable, predictable businesses that have paid dividends consistently and show no signs of dramatic business model change. Utilities, large consumer staples companies, and established financial services firms are the clearest fits.
Wall Street Prep, a financial training platform, notes that the GGM is "most applicable for mature companies with a consistent track record of profitability and issuance of dividends." Technology companies, early-stage growth firms, and cyclical businesses with unpredictable dividend patterns are poor candidates.
A 1% change in either r or g produces dramatic swings in the calculated stock price. If r is 9% and g is 4%, the denominator is 5%. Changing g from 4% to 5% halves the denominator and doubles the output price. This sensitivity is the model's most significant practical limitation.
The CFA Institute recommends using the GGM as one input in a broader valuation framework rather than as a standalone answer, precisely because small assumption changes produce such large price differences.
The GGM can be rearranged to express the justified forward price-to-earnings ratio, which is the multiple the market should reasonably pay for a stock's earnings. This application makes the model useful even when working with earnings data rather than dividends directly.
Analysts derive a market's implied long-term dividend growth rate from this version of the model by working backward from current prices. When the implied growth rate diverges significantly from the economy's long-run growth trajectory, it signals that the market is either too optimistic or too pessimistic about that stock or sector.
When a company is growing fast now but expected to slow down eventually, a single-stage GGM distorts the valuation. A two-stage dividend discount model applies a high growth rate during an initial finite period, then switches to a lower stable rate at the transition point.
The three-stage model adds a transition phase between high growth and stable growth, which better reflects how businesses actually mature over time. Both extensions preserve the GGM's core math but apply it across phases rather than assuming one constant growth rate from today forward.
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