Gordon Growth Model Calculator — Stock Valuation
Value a stock using the Gordon Growth Model (dividend discount model).
Enter dividend, required return, and growth rate.
What Is the Gordon Growth Model?
The Gordon Growth Model (also called the Dividend Discount Model or DDM) is one of the simplest and most elegant ways to estimate what a stock is truly worth.
The idea is straightforward: a stock is worth the present value of all the future dividends it will ever pay.
Think of it like buying a rental property. You would not care about the paint color or the fancy kitchen — you would care about how much rent it pays you every month, and whether that rent will grow over time. The Gordon Growth Model does the same thing for stocks, using dividends instead of rent.
The Formula
P = D₁ / (r - g)
Where:
- P = The fair price of the stock (what it should be worth)
- D₁ = Expected dividend next year (not last year’s dividend — next year’s)
- r = Required rate of return (what return you demand for the risk)
- g = Expected annual dividend growth rate (forever)
If you only know last year’s dividend (D₀), simply calculate:
D₁ = D₀ × (1 + g)
Why Must r Be Greater Than g?
The formula breaks if the growth rate equals or exceeds the required return. Mathematically, you would divide by zero or get a negative number, which makes no sense.
Intuitively, if dividends grow faster than your required return forever, the stock would be worth infinity — which is impossible. In the real world, no company can grow faster than the economy forever.
Worked Example
Suppose a stock just paid a dividend of $2.00 per share. You expect dividends to grow at 5% per year indefinitely. Your required return is 10%.
Step 1 — Next year’s dividend: D₁ = $2.00 × (1 + 0.05) = $2.10
Step 2 — Fair price: P = $2.10 / (0.10 - 0.05) = $2.10 / 0.05 = $42.00
If the stock currently trades at $35, it is undervalued (a potential buy). If it trades at $50, it is overvalued (potentially expensive).
Sensitivity Analysis
Small changes in the growth rate dramatically affect the price:
| Growth Rate (g) | D₁ | Required Return (r) | Fair Price |
|---|---|---|---|
| 3% | $2.06 | 10% | $29.43 |
| 4% | $2.08 | 10% | $34.67 |
| 5% | $2.10 | 10% | $42.00 |
| 6% | $2.12 | 10% | $53.00 |
| 7% | $2.14 | 10% | $71.33 |
A difference of just 2% in growth rate nearly doubles the fair price! This is why analysts are cautious about the assumptions they plug in.
When to Use This Model
The Gordon Growth Model works best for:
- Mature, stable companies that pay regular dividends (utilities, banks, consumer staples)
- Blue-chip stocks with a long history of consistent dividend growth
- Companies like Coca-Cola, Johnson & Johnson, or Procter & Gamble
It does NOT work well for:
- Companies that do not pay dividends (most tech companies)
- Companies with erratic or declining dividends
- Fast-growing companies where g might exceed r in the short term
Warren Buffett and Dividends
Warren Buffett has said he thinks about all investments in terms of their future cash flows discounted to the present. The Gordon Growth Model formalizes exactly this idea for dividend-paying stocks. While Buffett looks at many other factors too, the core concept is the same: what will this investment pay me over time, and what is that stream of payments worth today?
Limitations
- Assumes dividends grow at a constant rate forever (unrealistic for most companies)
- Very sensitive to the growth rate assumption
- Does not work for non-dividend-paying stocks
- Ignores share buybacks, which are another way companies return cash to shareholders