The model assumes a company exists forever and pays dividends that increase at a constant rate. To estimate the value of a stock, the model takes the infinite series of dividends per share and discounts them back into the present using the required rate of return. The result is a simple formula, which is based on mathematical properties of an infinite series of numbers growing at a constant rate.
How to Use the Gordon Growth Model
The intrinsic value of a stock can be found using the formula (which is based on mathematical properties of an infinite series of numbers growing at a constant rate):
Intrinsic value of stock = D÷(k-g)
D is the expected dividend per share, k is the investor's rate of return required and g is the expected dividend growth rate.
How to Calculate Intrinsic Value Using Excel
To get started, set up the following in an Excel spreadsheet:
- Enter "stock price" into cell A2
- Next, enter "current dividend" into cell A3.
- Then, enter the "expected dividend in one year" into cell A4.
- In cell A5, enter "constant growth rate."
- Enter the required rate of return into cell B6 and "required rate of return" in cell A6.
For example, suppose you are looking at stock ABC and want to figure out the intrinsic value of it. Assume you know the growth rate in dividends and also know the value of the current dividend.
The current dividend is $0.60 per share, the constant growth rate is 6%, and your required rate of return is 22 percent.
To determine the intrinsic value, plug the values from the example above into Excel as follows:
- Enter $0.60 into cell B3.
- Enter 6% into cell B5.
- Enter 22% into cell B6.
- Now, you need to find the expected dividend in one year. In cell B4, enter "=B3*(1+B5)", which gives you 0.64 for the expected dividend, one year from the present day.
- Finally, you can now find the value of the intrinsic price of the stock. In cell B2, enter "=B4÷(B6-B5)."
The current intrinsic value of the stock in this example is $3.98 per share.