The Gordon growth model (GGM) is a sequence of dividends that increase at a predictable rate in the future and is frequently used to calculate a stock’s intrinsic value. It’s a basic dividend discount concept (DDM). On the assumption that dividends may continue to rise at the same rate eternally, the GGM calculates the current value of an infinite series of future payouts. As a result, because the notion presupposes a constant growth rate, it is most typically encountered in companies that grow their dividend per share at a regular rate.
The Relationship between Strategy and Securities
It is beneficial to track ‘stock value’. A money-related approach works on stock costs in two ways:
- In undesirable situations, the co-operatives or monetary policy regulators reduce the interest rate on shares, which provides financial support to the holders. So, these situations reduce the amount of interest and decrease kG (the denominator in the Gordon Growth model). Reducing this amount will improve the stock price (stock cost). Consequently, the price of the stock increases in the market.
- Lowering the loan is a way for the organisations to revitalise and boost the economy, which will help with high profitability. An increase in profits can also cause the denominator kG to decrease and bring higher stock costs.
Gordon Model Formula
The Gordon Model formula is written as:
P = D1 / r – g
P = Value of current stock price
g = Constant growth rate
r = Constant cost of equity capital
D1 = Dividend value (at the end of 1st year.)
Properties of Gordon’s Model
Let’s learn about some properties of Gordon’s Model.
- The value of the Dividend is capitalised, when the value of g (growth) is zero.
P0 = D1/r
- The Gordon Model formula is also used to calculate the cost of capital. For this, we have to solve the value of r.
r = (D1/P0) + g
- Another formula derived from Gordon Model formula:
P0 = D1/ k – g
D = Dividend per share
k = rate of return
g = growth rate of dividend
P = Current stock value
Contribution of Gordon Model
DPS is an annual investment that the organisation makes to investors of incredible value, while the level of development of DPS is the yearly pace of profit growth. The required rate of return is the basic level of return at which the financiers will purchase the organisation’s stock.
Dividend Policy in Gordon Model
As demonstrated by Gordon’s Model, the company’s dividend strategy is essential; what’s more, it can affect the firm’s value. Like Walter’s Model, the firm’s value under this process likewise depends on the investment rate (r) and what investors think.
Assumptions
- No liability: The model accepts that an organisation has absolute values, without any obligation of capital construction
- No External Funding: The model expects all organisation activities to be funded by profits – no foreign investment is required
- Fixed IRR: The model expects Internal Revenue Level (r), which looks for negligible downtime business production
- Fixed Capital Costs: The model relies on the realisation of substantial capital costs (k); the estimates of the business risk of mass speculation have become very similar
- Endless Benefits: Gordon’s model believes in the idea of corporate profits
- Business costs: Business evaluations are not shown in this model
- Solid Maintenance Rate: The model receives a fixed portion of the maintenance (b) for a selected organisation
- As the level of development (g) = b * r, the level of development is similarly consistent with this reason
Criticism of Gordon Model
The primary criticism of the Gordon Model lies in its assumption of sustainable development of profits per share. It is exciting that organisations have shown continuous improvement in their earnings due to business cycles and surprising financial problems or victories. The following model is limited to organisations with stable development rates on profit per share. Another problem arises with the association of the discount factor and the development rate applied to the model. Assuming that the required recovery rate is not precisely the rate of profit development per share, the result is a negative value. Similarly, if the required recovery rate is equal to the development rate, the value of each share is imminent.
Solid Maintenance Rate: The model receives a fixed portion of the maintenance (b) for a selected organisation. As the level of development (g) = b * r, the level of development is similarly consistent with this reason.
K> g: Gordon model expects capital cost (k)> development rate (g). This is important to get an important part of the organisation component.
Conclusion
This model clearly shows how the financial system affects the trading of securities and financial backers, financiers, and donors at the time. It has often been seen that a securities exchange specialist recognises monetary methods as the financial system. It is often an essential change in determining stock costs and so on. Additionally, we should often be educated about the market, especially any new data about the expected assets that we intend to purchase. This is what is known as “market speculation”.
Frequently asked questions
Get answers to the most common queries related to the UPSC Examination Preparation.
What does the Gordon Model refer to?
Answer: The Gordon growth model (GGM) can be described as a sequence of dividends that increase at a predictable rat...Read full
Is the Gordon Model perfectly applicable to any of the companies?
Answer: The Gordon model applies to all the companies which are stable and have mature businesses.
How to use Gordon’s Model?
Answer: To use the Gordan development model, one must first know the annual profit statement and measure its future ...Read full
What is the main criticism of the Gordon Model?
Answer: It ignores non-profit factors, for example, product loyalty, client care, and accountability, all of which i...Read full
