Gordon’s Growth Model The Gordon Model is similar to the Discount Cash Flow model. It assumes the dividends the company pays have a constant growth rate and that a stock is worth all the dividends it pays in the future discounted to the present. This is in itself also the major flaw of the model as many companies do not pay dividend and therefore by the thesis of the model, have no value. The Gordon Model Where: P = Price of the
stock according to the model D = is the total
dividend paid for the last year (= quarterly dividend * 4) k = discount rate
(%) g = growth rate of
the dividends (%)
The discount rate can be calculated using the Capital Asset Pricing Model (CAPM). k = (M – r)*b + r Where:k = discount rate
(%)M = expected market
return (usually the long term average of 9%) r = risk-free rate
(30y treasury bond annual return %) b = stock’s beta
(you can get this from pretty much any financial site) Example of the Gordon Model Lets take the Coca-Cola Company (KO), for example. KO’s beta is 0.61, and the 30y Treasury bond is 3.8% at the time of writing. We’ll stick with 9% expected return on the market. So the discount rate is 7%.
KO’s last year dividend was $1.73. I’m assuming the dividends are going to grow 5% per annum, which is conservative when compared to the past. So the intrinsic value of KO is $90.83.
Comparing this to the stock current stock price of $58.62 shows that KO is undervalued by some 50%! |
