How to Calculate Growth Rate in Gordon Model

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Gordon Growth Model (GGM) Growth Rate Calculator

Results

Implied Growth Rate (g):

function calculateGGMGrowth() { var P = parseFloat(document.getElementById('stockPrice').value); var D1 = parseFloat(document.getElementById('nextDividend').value); var rPercent = parseFloat(document.getElementById('requiredReturn').value); var r = rPercent / 100; var resultDiv = document.getElementById('ggm-result-container'); var growthSpan = document.getElementById('growthResult'); var analysisText = document.getElementById('ggm-analysis'); if (isNaN(P) || isNaN(D1) || isNaN(rPercent) || P = rPercent) { analysisText.innerText = "Note: The calculated growth rate is equal to or higher than the required return. In a standard Gordon Model, 'g' must be less than 'r' for the model to be mathematically stable over the long term."; } else if (gPercent < 0) { analysisText.innerText = "The implied growth rate is negative, suggesting the market expects a contraction in dividends over time given the current price and return requirements."; } else { analysisText.innerText = "This growth rate represents the constant annual percentage at which dividends are expected to grow to justify the current stock price."; } }

Understanding Growth Rate in the Gordon Model

The Gordon Growth Model (GGM), also known as the Dividend Discount Model (DDM), is a method used to determine the intrinsic value of a stock based on a future series of dividends that grow at a constant rate. While it is often used to solve for the price, investors frequently use it to calculate the Implied Growth Rate to see if market expectations are realistic.

The Formula

g = r – (D₁ / P)

  • g: Constant Growth Rate
  • r: Required Rate of Return (Cost of Equity)
  • D₁: Expected dividend per share one year from now
  • P: Current Market Price of the stock

Step-by-Step Calculation Example

Imagine you are analyzing "BlueChip Corp" with the following data:

  1. Current Price (P): $100.00
  2. Next Year's Dividend (D₁): $4.00
  3. Your Required Return (r): 9% (0.09)

To find the growth rate (g):

Step 1: Divide the dividend by the price: 4 / 100 = 0.04

Step 2: Subtract that result from your required return: 0.09 – 0.04 = 0.05

Step 3: Convert to a percentage: 0.05 * 100 = 5%

This means that for the stock to be worth $100 today with a 9% return, dividends must grow at a constant rate of 5% annually.

Why Calculate the Implied Growth Rate?

Investors calculate 'g' to perform a "sanity check." If the GGM suggests a growth rate of 12% for a mature company in a slow-growing industry (like utilities), the stock might be overvalued, or the market is making overly optimistic assumptions. Conversely, if 'g' is very low or negative for a strong company, it may indicate a buying opportunity.

Limitations to Consider

  • Constant Growth: The model assumes growth remains the same forever, which is rarely true for real companies.
  • Sensitivity: Small changes in the required return (r) or dividend (D₁) can lead to large swings in the calculated growth rate.
  • r > g: The math fails if the growth rate is expected to be higher than the required rate of return indefinitely.

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