Results
Please enter the values above to calculate the intrinsic stock price.
Understanding the Calculation
This calculator uses the Dividend Discount Model (DDM), specifically the Gordon Growth Model, to estimate the intrinsic value of a stock. The Gordon Growth Model is suitable for mature companies that are expected to pay dividends that grow at a constant rate indefinitely.
The Formula:
The formula is: \( P_0 = \frac{D_1}{k – g} \)
- \( P_0 \) = The current intrinsic value of the stock.
- \( D_1 \) = The expected dividend per share in the next period (Year 1).
- \( k \) = The required rate of return (or discount rate).
- \( g \) = The constant growth rate of dividends.
How it works:
The model assumes that the future dividends will grow at a steady rate, and it discounts these future dividends back to their present value using the required rate of return. A higher current dividend, a higher growth rate, or a lower required rate of return will lead to a higher estimated stock price.
Assumptions and Limitations:
- The model assumes that dividends will grow at a constant rate indefinitely, which may not be realistic for all companies.
- The growth rate (g) must be less than the required rate of return (k). If g is greater than or equal to k, the formula yields a negative or infinite stock price, which is not meaningful.
- This model is best suited for established, dividend-paying companies with a stable growth history. It's less appropriate for high-growth companies or those that do not pay dividends.
Example Calculation:
Let's say a company currently pays an annual dividend of $2.00 per share. We expect this dividend to grow by 5% annually. An investor requires a 10% rate of return on this investment.
- Current Annual Dividend ($D_0$): $2.00
- Expected Dividend Growth Rate ($g$): 5% or 0.05
- Required Rate of Return ($k$): 10% or 0.10
First, we need to calculate the expected dividend for the next year ($D_1$):
$$ D_1 = D_0 \times (1 + g) = \$2.00 \times (1 + 0.05) = \$2.10 $$
Now, we can plug these values into the Gordon Growth Model formula:
$$ P_0 = \frac{D_1}{k – g} = \frac{\$2.10}{0.10 – 0.05} = \frac{\$2.10}{0.05} = \$42.00 $$
Therefore, based on these assumptions, the intrinsic value of the stock is estimated to be $42.00 per share.
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function calculateStockPrice() {
var currentDividend = parseFloat(document.getElementById("currentDividend").value);
var dividendGrowthRate = parseFloat(document.getElementById("dividendGrowthRate").value) / 100;
var requiredRateOfReturn = parseFloat(document.getElementById("requiredRateOfReturn").value) / 100;
var resultDiv = document.getElementById("result");
if (isNaN(currentDividend) || isNaN(dividendGrowthRate) || isNaN(requiredRateOfReturn)) {
resultDiv.innerHTML = "Please enter valid numbers for all fields.";
return;
}
if (dividendGrowthRate >= requiredRateOfReturn) {
resultDiv.innerHTML = "Error: The dividend growth rate cannot be greater than or equal to the required rate of return for this model.";
return;
}
// Calculate next year's dividend (D1)
var nextDividend = currentDividend * (1 + dividendGrowthRate);
// Calculate intrinsic stock price using Gordon Growth Model
var intrinsicStockPrice = nextDividend / (requiredRateOfReturn – dividendGrowthRate);
// Display the result
resultDiv.innerHTML = "Next Year's Expected Dividend (D1):
$" + nextDividend.toFixed(2) + "" +
"Estimated Intrinsic Stock Price (P0):
$" + intrinsicStockPrice.toFixed(2) + "";
}