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Constant Growth Model:
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The Constant Growth Model (also known as the Gordon Growth Model) is used to determine the intrinsic value of a stock based on future dividends that grow at a constant rate. It assumes dividends will continue to grow at a steady rate indefinitely.
The calculator uses the Constant Growth Model equation:
Where:
Explanation: The model calculates the present value of an infinite series of future dividends that grow at a constant rate.
Details: Accurate stock valuation is crucial for investors to make informed decisions about buying, holding, or selling stocks. The constant growth model is particularly useful for valuing mature companies with stable dividend growth.
Tips: Enter the expected dividend (D1) in USD, required return (k) as a decimal (e.g., 0.08 for 8%), and growth rate (g) as a decimal. The growth rate must be less than the required return.
Q1: What types of stocks is this model best suited for?
A: The model works best for stable, mature companies with a history of consistent dividend growth, such as utility companies or established blue-chip stocks.
Q2: What happens if g ≥ k?
A: The model breaks down mathematically if growth rate equals or exceeds required return, as this would imply infinite stock value.
Q3: How do I estimate the required return (k)?
A: The required return is often estimated using the Capital Asset Pricing Model (CAPM) or based on the investor's required rate of return.
Q4: What are the limitations of this model?
A: The model assumes constant growth forever, which may not be realistic. It also doesn't work for companies that don't pay dividends.
Q5: Can this model be used for growth stocks?
A: No, this model is not suitable for growth stocks that reinvest earnings rather than pay dividends, or for companies with variable growth rates.