Gordon Growth Model

(noun)

Gordon Growth Model is also called the dividend discount model (DDM), which is a way of valuing a company based on the theory that a stock is worth the discounted sum of all of its future dividend payments.

Examples of Gordon Growth Model in the following topics:

  • Expected Dividends and Constant Growth

    • Valuations rely heavily on the expected growth rate of a company; past growth rate of sales and income provide insight into future growth.
    • One must look at the historical growth rate of both sales and income to get a feeling for the type of future growth expected.
    • A generalized version of the Walter model (1956), SPM considers the effects of dividends, earnings growth, as well as the risk profile of a firm on a stock's value.
    • Derived from the compound interest formula using the present value of a perpetuity equation, SPM is an alternative to the Gordon Growth Model.
    • The Gordon model or Gordon's growth model is the best known of a class of discounted dividend models .

  • Discounted Dividend vs. Corporate Valuation

    • The dividend discount model values a firm at the discounted sum of all of its future dividends, and does not factor in income or assets.
    • The equation most always used is called the "Gordon Growth Model. " It is named after Myron J.
    • Gordon who originally published it in 1959, although the theoretical underpin was provided by John Burr Williams in his 1938 text The Theory of Investment Value.
    • b) If the stock does not currently pay a dividend, like many growth stocks, more general versions of the discounted dividend model must be used to value the stock.
    • c) The stock price resulting from the Gordon model is hypersensitive to the growth rate chosen.

  • Valuing Nonconstant Growth Dividends

    • Limited high-growth approximation, implied growth models, and the imputed growth acceleration ratio are used to value nonconstant growth dividends.
    • While these DCF models are commonly used, the uncertainty in these values is hardly ever discussed.
    • Note that the models diverge for and hence are extremely sensitive to the difference of dividend growth to discount factor.
    • One can use the Gordon model or the limited high-growth period approximation model to impute an implied growth estimate.
    • Subsequently, one can divide this imputed growth estimate by recent historical growth rates.

  • Other Important Trait Theories

    • The disposition theory, three fundamental traits, and HEXACO model of personality structure are applicable to the work place.
    • Some of these traits include Gordon Allport's dispositions, Hans Eysenck's three fundamental traits, and Michael Aston and Kibeom Lee's six dimensional HEXACO model of personality structure.
    • Gordon Allport's disposition theory includes cardinal traits, central traits, and secondary traits.
    • The third dimension, psychoticism, was added to the model in the late 1970s as a result of collaborations between Eysenck and his wife, Sybil B.
    • American psychologist Gordon Allport wrote an influential work on prejudice, The Nature of Prejudice, published in 1979.

  • The "New Economy" of the 1990s

    • However, around 1995, U.S. economic growth accelerated, driven by faster productivity growth.
    • From 1972 to 1995, the growth rate of output per hour, a measure of labor productivity, had only averaged around 1% per year.
    • By the mid 1990s, however, growth became much faster, averaging 2.65% from 1995 to 1999.
    • Gordon referred to this as a "Goldilocks economy," the result of five positive "shocks": the "two traditional shocks (food-energy and imports) and the three new shocks (computers, medical care, and measurement)."
    • Newspapers and business leaders talked of new business models; some even claimed that the old laws of economics did not apply anymore and that new laws had taken their place.

  • Investor Preferences

    • This view is supported by both the Walter and Gordon models, which find that investors prefer those firms which pay regular dividends, and such dividends affect the market price of the share.
    • Gordon's dividend discount model states that shareholders discount the future capital gains at a higher rate than the firm's earnings, thereby evaluating a higher value of the share.

  • Economic Growth as a Measuring Stick

    • Classical Growth Theory: Dating back to Adam Smith and the foundation of capitalism, classical growth theory uses the production function to measure economic growth.
    • In this model, the overall growth of an economy will compound exponentially and capture economies of scale, implying that economic expansion via consistent growth is a reasonable proposition.
    • Growth Accounting: Growth accounting came into popularity after the classical model, identifying the crucial role of technology in economic growth.
    • In this scenario, technological leaps and bounds can be captured in the overall growth model.
    • Endogenous Growth Model: This model takes into account technology, as in the growth accounting system discussed above, alongside increases in skills and intellectual capital.

  • Essential Functions for Mathematical Modeling

    • The process of developing a mathematical model is termed mathematical modeling.
    • For example, a simple model of population growth is the Malthusian growth model.
    • This is essentially exponential growth based on a constant rate of compound interest: $P(t)=P_0e^{rt}$ where $P_0=P(0)=\text{initial population}$, $r$ is the growth rate, and $t$ is the time.
    • A slightly more realistic and largely used population growth model is the logistic function that may be defined by the formula: $P(t) = \frac{1}{1 + e^{-t}}$.
    • The graph illustrates how exponential growth (green) surpasses both linear (red) and cubic (blue) growth.

  • Limited Growth

    • Exponential growth may dampen approaching a certain value, modeled with the logistic growth model: $P(t)=\frac{c}{1+a\cdot e^{-bt}}$.
    • Exponential functions can be used to model growth and decay.
    • Saying that an exponential function models population growth exactly means that the human population will grow without bound.
    • The death rate of sheep will increase as some starve, and thus the model of population growth among sheep will change form.
    • To account for limitations in growth, the logistic growth model can be used.

  • Logistic Population Growth

    • To model the reality of limited resources, population ecologists developed the logistic growth model.
    • Thus, the exponential growth model is restricted by this factor to generate the logistic growth equation:
    • This model also allows for negative population growth or a population decline.
    • A graph of this equation yields an S-shaped curve ; it is a more-realistic model of population growth than exponential growth.
    • Still, even with this oscillation, the logistic model is confirmed.