Constant Growth Stock Valuation

The Constant Growth Model (also known as Gordon Growth Model) is a financial model used to determine the intrinsic value of a stock. It assumes that a company grows at a constant rate and can be calculated as follows:

Formula:
Po = D1 / ( r - g )
Or,
Po = D0 (1 + g) / ( r - g )

where
P0 =  stock price
D0 = current dividend
D1 = the next dividend
g = the growth rate in dividends
r = required rate of return on the stock

Example:
Last year's dividend = $2.00
Growth Rate = 3%
Rate of Return = 8%
Find the stock price.

Solution:
Po = D0 (1 + g) / ( r - g ) = 2 (1 + 0.03) / (0.08 - 0.03) = 2.06 / 0.05 = $41.20
Therefore, an investor will be willing to pay $41.20 for the stock if he/she want to get an 8% rate of return on stock, assume that the company will grow forever at 3% per annum.

* Next: How to Calculate Shareholder Funds
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