A:

The Gordon Growth Model, or the dividend discount model (DDM), is a model used to calculate the intrinsic value of a stock based on the present value of future dividends that grow at a constant rate.

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

Using the Gordon Growth Model to find intrinsic value is fairly simple to calculate in Microsoft Excel.

To get started, set up the following in an Excel spreadsheet:

  1. Enter "stock price" into cell A2
  2. Next, enter "current dividend" into cell A3.
  3. Then, enter the "expected dividend in one year" into cell A4.
  4. In cell A5, enter "constant growth rate." 
  5. 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:

  1. Enter $0.60 into cell B3.
  2. Enter 6% into cell B5.
  3. Enter 22% into cell B6.
  4. 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.
  5. 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.

RELATED FAQS
  1. How do I calculate how long it takes an investment to double (AKA 'The Rule of 72') ...

    Find out more about the rule of 72, what the rule of 72 measures and how to calculate the rule of 72 for investments using ... Read Answer >>
  2. Intrinsic Value vs Current Market Value

    Discover the differences between intrinsic and market values, what makes the former difficult to determine, and how investor ... Read Answer >>
  3. How do you calculate return on equity (ROE) in Excel?

    Find out more about return on equity, the formula to calculate ROE and how to calculate this measure of a company's profitability ... Read Answer >>
  4. How do you calculate a payout ratio using Excel?

    Learn what the payout ratio is, what dividends per share and earnings per share are, and how the payout ratio is calculated ... Read Answer >>
Related Articles
  1. Investing

    What Is The Intrinsic Value Of A Stock?

    Intrinsic value reduces the subjective perception of a stock's value by analyzing its fundamentals.
  2. Investing

    Valuation Of A Preferred Stock

    Determining the value of a preferred stock is important for your portfolio. Learn how it's done.
  3. Investing

    Is Dividend Investing a Good Strategy?

    Understanding dividends and how they generate steady income for shareholders will help you become a more informed and successful investor.
  4. Investing

    Put Dividends to Work in Your Portfolio

    Find out how a company can put its profits directly into your hands.
  5. Investing

    Warren Buffett and Berkshire's Productive Assets

    Here are some methods to measure whether an investment will be "productive."
RELATED TERMS
  1. Value

    Value is the monetary, material or assessed worth of an asset, ...
  2. Time Value

    The portion of an option's premium that is attributable to the ...
  3. Manufacturing Cells

    Manufacturing cells are sets of machines that are grouped by ...
  4. Margin of Safety

    Margin of safety is an investing principle that involves only ...
  5. Stock Dividend

    A stock dividend, also known as a scrip dividend, is a dividend ...
  6. Gross Dividends

    Gross dividends are the sum total of all dividends received, ...
Trading Center