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Constant Growth Model:
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The Constant Growth Model (also known as the Gordon Growth Model) is a method of valuing a company's stock price based on the theory that its dividend will grow at a constant rate indefinitely. It's particularly useful for valuing mature companies with stable dividend growth rates.
The calculator uses the Constant Growth Model equation:
Where:
Explanation: The model assumes dividends will continue to grow at a constant rate forever, and discounts them back to present value.
Details: Accurate stock valuation is crucial for investors to determine whether a stock is overvalued or undervalued compared to its market price, helping make informed investment decisions.
Tips: Enter the expected dividend in USD, required rate of return as a decimal (e.g., 0.08 for 8%), and growth rate as a decimal. The growth rate must be less than the required rate of return.
Q1: When is the constant growth model appropriate?
A: It's most appropriate for mature, stable companies with a history of steady dividend growth and predictable future growth rates.
Q2: What if the growth rate exceeds the required return?
A: The model breaks down mathematically (resulting in negative value) as this situation is unsustainable in the long term.
Q3: How do I estimate the required rate of return?
A: It's typically estimated using the Capital Asset Pricing Model (CAPM) or based on the investor's required return for that risk level.
Q4: What are limitations of this model?
A: It doesn't work well for companies that don't pay dividends, have unstable growth rates, or are in rapidly changing industries.
Q5: Can this model be used for growth stocks?
A: No, growth stocks typically reinvest earnings rather than pay dividends, so multi-stage models are more appropriate.