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Constant Growth Stock Formula:
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The Constant Growth Stock Formula, also known as the Gordon Growth Model, is used to determine the intrinsic value of a stock based on a future series of dividends that grow at a constant rate. It's particularly useful for valuing mature companies with stable dividend growth.
The calculator uses the constant growth formula:
Where:
Explanation: The model assumes dividends will continue to grow at a constant rate indefinitely, and discounts them back to present value.
Details: Accurate stock valuation is crucial for investors to make informed decisions about buying, holding, or selling stocks. The constant growth model provides a simple yet powerful tool for valuing dividend-paying stocks.
Tips: Enter the current dividend in USD, growth rate as a decimal (e.g., 0.05 for 5%), and required rate of return as a decimal. The growth rate must be less than the required rate of return for the formula to work.
Q1: When is the constant growth model appropriate?
A: It works best 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 (denominator becomes negative or zero). This suggests the company is growing unsustainably fast.
Q3: How do I estimate the required rate of return?
A: It's typically based on the risk-free rate plus a risk premium. The CAPM model is often used to estimate it.
Q4: What are limitations of this model?
A: It doesn't work for non-dividend paying stocks or companies with unstable growth rates. It also assumes perpetual growth.
Q5: Can this model be used for growth stocks?
A: Not directly. For growth stocks, multi-stage models that combine periods of high growth with eventual stable growth are more appropriate.