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. Why is the Gordon Growth Model not more widely used?

    Learn why the Gordon growth model is not more widely used in valuing the stock price of a company. Understand its inefficiencies ... Read Answer >>
  3. What kinds of companies are the best candidates for evaluation using the Gordon Growth ...

    Learn what the Gordon growth model is, how it's used to value a company and what candidates are best suited for evaluation ... Read Answer >>
  4. How is perpetuity used in the Dividend Discount Model?

    Learn about how the concept of a stock perpetuity is used in the basic dividend discount model, which is also known as the ... Read Answer >>
  5. What is the difference between Macaulay duration and modified duration?

    Find out more about the forward price to earnings ratio and how to calculate the forward price to earnings ratios of companies ... Read Answer >>
  6. What is the difference between intrinsic value and current market value?

    Discover the differences between intrinsic and market values, what makes the former difficult to determine and how investor ... Read Answer >>
Related Articles
  1. Investing

    What Is The Intrinsic Value Of A Stock?

    Intrinsic value can be subjective and difficult to estimate. It’s a perception of a security’s value that factors tangible and intangible factors.
  2. Investing

    Valuing A Stock With Supernormal Dividend Growth Rates

    If these calculations are off, it could drastically change the value of the shares.
  3. Investing

    Microsoft Is Paying Dividends. Is Its Share Price Undervalued Or Overvalued Based On DDM? (MSFT)

    How can you use the dividend discount model to estimate the value the common stock of Microsoft?
  4. Financial Advisor

    Is Texas Instruments a Good Value Play? (TXN)

    Find out whether investors and analysts believe that Texas Instruments would make a good value play at its current valuation, and learn more about its outlook.
  5. Investing

    Discounted Cash Flow (DCF)

    Discover how investors can use this valuation method to determine the intrinsic value of a stock.
  6. Investing

    Valuation Of A Preferred Stock

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

    The 3 Biggest Misconceptions of Dividend Stocks

    To find the best dividend stocks, focus on total return, not yield.
  8. Investing

    Due Diligence On Dividends

    Understanding dividends and how they work will help you become a more informed and successful investor.
RELATED TERMS
  1. Gordon Growth Model

    A model for determining the intrinsic value of a stock, based ...
  2. Financial Modeling

    The process by which a firm constructs a financial representation ...
  3. Dividend

    A dividend is a distribution of a portion of a company's earnings, ...
  4. Valuation

    The process of determining the current worth of an asset or company. ...
  5. Forward Dividend Yield

    An estimation of a year's dividend expressed as a percentage ...
  6. Large-Value Stock

    A large-value stock is the stock of a large company where the ...
Hot Definitions
  1. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  2. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  3. Risk Tolerance

    The degree of variability in investment returns that an individual is willing to withstand. Risk tolerance is an important ...
  4. Donchian Channels

    A moving average indicator developed by Richard Donchian. It plots the highest high and lowest low over the last period time ...
  5. Consumer Price Index - CPI

    A measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, ...
  6. Moving Average - MA

    A moving average (MA) is a widely used indicator in technical analysis that helps smooth out price action by filtering out ...
Trading Center