Valuing a stock by its dividends
A share is worth the cash it will pay its owner in the future. For a company that pays a steadily growing dividend, the Gordon growth model, published by Myron Gordon in 1959, turns this idea into a one-line formula. It is the simplest form of the dividend discount model and a cornerstone of finance courses.
The formula
- Next dividend D1 = current dividend × (1 + g)
- Intrinsic value = D1 ÷ (k − g)
- Return implied by the price = D1 ÷ price + g
Here g is the dividend growth rate and k the return you require, often estimated with the CAPM. The model only works when k is greater than g.
Worked example
A stock pays $2.00 a year in dividends, which grow 4% a year. You require an 8% return, and the stock trades at $45.
- D1 = 2.00 × 1.04 = $2.08.
- Value = 2.08 ÷ (0.08 − 0.04) = $52.00.
- The value is 15.6% above the market price.
- At $45, the stock offers 2.08 ÷ 45 + 4% = 8.62%, slightly more than you require.
Very sensitive to its inputs
| Required return | Value per share | vs. $45 price |
|---|---|---|
| 6% | $104.00 | +131.1% |
| 7% | $69.33 | +54.1% |
| 8% | $52.00 | +15.6% |
| 9% | $41.60 | −7.6% |
| 10% | $34.67 | −23.0% |
| 12% | $26.00 | −42.2% |
A one-point change in k or g can move the value by 20 to 50%. Treat the result as a range, not a precise price, and test several assumptions.
Choosing the growth rate
The growth rate must be sustainable forever, so it should not exceed the long-run growth of the economy, about 4 to 5% a year in nominal terms for the US. Useful checks are the company’s dividend history over 10 years and its sustainable growth rate: return on equity × (1 − payout ratio).
When to use another model
The model fits mature dividend payers such as utilities, consumer staples, telecoms and large banks. For companies that pay no dividend, use a discounted cash flow model or multiples such as the P/E. For fast growers, use a multi-stage dividend model, with a high-growth period followed by a stable phase valued with the Gordon formula.
This calculator gives estimates for education and planning. It is not investment, tax or legal advice; for decisions about your own situation, talk to a qualified financial professional.