What this calculator does
The Gordon growth model values a share as the present value of its dividends, growing forever at a constant rate. It is the simplest complete valuation model there is, needing only three numbers.
It is also acutely sensitive to one of them. A $2.20 dividend at a 9 per cent required return is worth $24.44 with no growth, $44.00 at 4 per cent growth, and $73.33 at 6 per cent. Small changes in an assumption about the distant future dominate the answer.
The formula
Divide next year's expected dividend by the required return minus the growth rate, both as decimals. The model requires the return to exceed the growth rate, or the value does not converge.
| Term | Meaning |
|---|---|
| D1 | Next year's expected dividend, not this year's. |
| Required return (r) | The return an investor demands, often from CAPM. |
| Growth rate (g) | The perpetual dividend growth rate, which must be below the required return. |
The inputs explained
| Field | What to enter |
|---|---|
| Expected dividend next year ($) | The dividend expected over the next year, per share. |
| Required return (cost of equity) (%) | The required return on equity, as a percentage. |
| Expected dividend growth rate (%) | The assumed perpetual growth rate of dividends. |
When to use it
Valuing a stable dividend payer
Utilities and established consumer businesses with predictable dividends are where the model works best.
Working backwards from a price
Solving for the growth rate implied by the current price shows what the market is assuming.
Testing sensitivity
Varying the growth rate reveals how much of the valuation rests on an unverifiable assumption.
Worked examples
Every figure in the tables below is produced by this page’s own calculator at build time, so the numbers and the tool always agree. Select any row to load that scenario.
How much does the growth assumption matter?
The same dividend under four growth assumptions.
| Growth rate | Fair value per share | Implied dividend yield at this price |
|---|---|---|
| 0% | $24.44 | 9.00% |
| 2% | $31.43 | 7.00% |
| 4% | $44.00 | 5.00% |
| 6% | $73.33 | 3.00% |
Questions
Why must the growth rate be below the required return?
Because otherwise the dividends grow faster than they are discounted, and the sum is infinite. Mathematically the model breaks down; practically, no company can grow faster than the economy forever.
What about companies that pay no dividend?
The model cannot value them, which is a real limitation. Free cash flow models or multiples are the usual alternatives for growth companies that retain all earnings.
Why is the model so sensitive to growth?
Because the denominator is the difference between two similar numbers. When the required return is 9 per cent and growth is 6 per cent, the denominator is only 3, so a small change in either figure moves it proportionally a great deal.
Is this a reliable way to value shares?
It is a useful framework rather than a precise tool, and it should not be the basis of an investment decision on its own. Its main value is in making the assumptions behind a price explicit. Anyone investing real money should seek licensed advice.
For estimating the required return it needs, see the CAPM calculator. For the current dividend relative to price, see the dividend yield and payout calculator.