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The Gordon growth model values a share by dividing its next expected dividend by the required return less the perpetual dividend growth rate. Use it when a company pays dividends that can plausibly grow at a stable rate indefinitely, and only when the required return exceeds that growth rate. A dividend already paid is a starting point for forecasting the next payment, not the payment to put directly in the numerator.
Choose the cash flow before the formula
A dividend discount model treats shareholder distributions as the cash flows being valued. CFA Institute places it among present value methods and distinguishes dividends from free cash flow and residual income. For a minority shareholder, a regular payout linked to the company’s earnings makes dividends a defensible input. A company that retains cash while paying little, or changes payouts unpredictably, calls for a different cash-flow measure or a more detailed forecast. See the CFA programme overview for the broader study context.
The constant-growth assumption does substantial work: it replaces a long list of forecasts with one growth rate. That simplicity is useful only if the business and its dividend policy support it. CFA Institute’s discounted dividend reading also treats changing growth as a reason to use a multistage model.
Calculate value from the next payment
Suppose, purely for illustration, a share has just paid £2.00, dividends are expected to rise by 2% each year indefinitely, and the required equity return is 10%. Forecast the next dividend first: £2.00 times 1.02 equals £2.04. The gap between the required return and growth is eight percentage points, or 0.08. Dividing £2.04 by 0.08 gives an illustrative value of £25.50 per share.
Putting £2.00 directly over 0.08 would give £25.00. That figure silently treats the payment just made as though it were due in the future. The timing mistake looks small here, but it is still a different cash-flow stream. Recheck which dividend a question calls “current”, “just paid” or “expected next”.
Interpret the result carefully
The denominator must be positive. As growth approaches the required return, the estimated value becomes unusually sensitive to small changes in either input. A mechanically precise result can therefore rest on a fragile long-run assumption. CFA Institute’s equity valuation overview frames model choice around the information available and the pattern of future dividends.
For exam work, identify the dividend date, check whether stable growth is credible, then calculate. If the question describes an initial burst of growth followed by a mature phase, a single perpetual rate skips the very change you need to value. The valuation methodology is a useful place to connect that model choice to a wider study approach.
Sources
- Discounted Dividend Valuation | CFA Institute · cfainstitute.org · Retrieved
- Equity Valuation: Concepts and Basic Tools | CFA Institute · cfainstitute.org · Retrieved
