Imagine being able to predict the true value of a stock using a simple, elegant formula that investors have trusted for decades. That’s the power of the Gordon Growth Model, a valuation tool that helps you determine whether a dividend-paying stock is overpriced, underpriced, or just right. Whether you’re a beginner looking to start earning passive income through dividend investing or an experienced investor fine-tuning your portfolio, understanding this model can transform how you evaluate stocks.
TL;DR
- The Gordon Growth Model is a dividend discount method that calculates a stock’s intrinsic value based on future dividends growing at a constant rate
- Formula: Stock Value = D₁ ÷ (r-g), where D₁ is next year’s dividend, r is the required rate of return, and g is the dividend growth rate
- Best for: Mature, stable companies with consistent dividend growth like utilities, consumer staples, and blue-chip stocks
- Limitation: Only works when the growth rate is lower than the required return and assumes constant dividend growth forever
- Practical use: Helps investors identify undervalued dividend stocks and make informed, smart investment decisions
What Is the Gordon Growth Model?
In simple terms, the Gordon Growth Model (GGM) is a method for calculating the intrinsic value of a stock based on future dividends that are expected to grow at a constant rate indefinitely.
Also known as the Dividend Discount Model (DDM) or the constant growth model, this valuation technique was developed by economist Myron J. Gordon in the 1960s. The model assumes that a company will continue paying dividends that grow at a steady percentage each year, forever.
The Gordon Growth Model is particularly useful for evaluating mature, dividend-paying companies with predictable growth patterns. Think of established businesses like Coca-Cola, Procter & Gamble, or Johnson & Johnson companies that have demonstrated consistent dividend growth over decades.
Why does this matter? Understanding a stock’s true value helps you avoid overpaying during bull markets and identify bargains during downturns. This is especially important when navigating the cycle of market emotions that can cloud judgment.
The Gordon Growth Model Formula Explained
The beauty of the Gordon Growth Model lies in its simplicity. Here’s the formula:
Stock Value = D₁ ÷ (r-g)
Let’s break down each component:
- D₁ = Expected dividend per share one year from now
- r = Required rate of return (also called the discount rate or cost of equity)
- g = Expected constant growth rate of dividends in perpetuity
Understanding Each Variable
D₁ (Next Year’s Dividend):
This represents the dividend you expect the company to pay in the next 12 months. If the company just paid a $2.00 dividend and you expect 5% growth, then D₁ = $2.00 × 1.05 = $2.10.
r (Required Rate of Return):
This is the minimum return you demand for investing in this stock, considering its risk level. It typically includes the risk-free rate (like Treasury bonds) plus a risk premium. For most dividend stocks, investors might require 8-12% annual returns.
g (Growth Rate):
This is the perpetual annual rate at which dividends are expected to grow. You can estimate this by looking at historical dividend growth rates, industry trends, and company fundamentals.
The Critical Rule
Important: The growth rate (g) must always be less than the required return (r). If g ≥ r, the formula breaks down mathematically and produces nonsensical results.
Step-by-Step Calculation Example
Let’s walk through a real-world example to see the Gordon Growth Model in action.
Example: Valuing ABC Corporation
Given information:
- Most recent annual dividend (D₀): $3.00 per share
- Expected dividend growth rate (g): 6% per year
- Required rate of return (r): 10% per year
- Current stock price: $85 per share
Step 1: Calculate D₁ (next year’s dividend)
D₁ = D₀ × (1 + g)
D₁ = $3.00 × (1.06)
D₁ = $3.18
Step 2: Apply the Gordon Growth Model formula
Stock Value = D₁ ÷ (r-g)
Stock Value = $3.18 ÷ (0.10 – 0.06)
Stock Value = $3.18 ÷ 0.04
Stock Value = $79.50
Step 3: Compare to the current market price
- Intrinsic value: $79.50
- Current price: $85.00
- Conclusion: The stock appears overvalued by about $5.50 per share (6.9%)
According to this analysis, you might wait for the price to drop before buying, or look for better opportunities among high dividend stocks that offer better value.
Real-World Example: Coca-Cola Company
Let’s apply the Gordon Growth Model to a real company that many investors know and love.
Coca-Cola (KO) Valuation Example
Company background:
Coca-Cola is a classic dividend aristocrat with over 60 years of consecutive dividend increases, exactly the type of stable, mature company the Gordon Growth Model was designed for.
Hypothetical data (for illustration):
- Current annual dividend: $1.76 per share
- Historical 5-year dividend growth rate: 3.5%
- Required rate of return: 9% (based on risk assessment)
Calculation:
D₁ = $1.76 × 1.035 = $1.82
Stock Value = $1.82 ÷ (0.09 – 0.035)
Stock Value = $1.82 ÷ 0.055
Stock Value = $33.09
If Coca-Cola were trading at $30, it would be undervalued and potentially a good buy. If trading at $40, it would be overvalued according to this model.
Real-world consideration: Professional analysts often use multiple valuation methods alongside the Gordon Growth Model, including price-to-earnings ratios, discounted cash flow analysis, and comparative company analysis.
📊 Gordon Growth Model Calculator
Calculate the intrinsic value of dividend-paying stocks
Advantages of the Gordon Growth Model
The Gordon Growth Model has remained popular among investors and analysts for good reason. Here are its key strengths:
Simplicity and Ease of Use
Unlike complex multi-stage valuation models, the GGM requires only three inputs. You don’t need advanced financial modeling skills or expensive software — just basic arithmetic and reasonable assumptions.
Focus on Fundamentals
The model emphasizes what truly matters for long-term investors: dividends and growth. This keeps you focused on companies that actually return cash to shareholders rather than chasing speculative growth stories.
Conservative Approach
By assuming constant, modest growth, the Gordon Growth Model tends to produce conservative valuations. This built-in margin of safety helps protect against overpaying for stocks.
Perfect for Dividend Investors
If you’re building a portfolio of high dividend stocks for passive income, this model helps you identify which companies offer the best value relative to their dividend payments.
Quick Comparison Tool
The GGM allows rapid comparison between similar companies. You can quickly screen dozens of dividend stocks to find the most attractively priced opportunities.
Limitations and Drawbacks
No valuation model is perfect, and the Gordon Growth Model comes with significant limitations that every investor must understand.
Constant Growth Assumption
The biggest flaw: Assuming dividends will grow at the same rate forever is unrealistic. Companies go through cycles — periods of high growth, maturity, and sometimes decline.
Real-world impact: This makes the model unsuitable for:
- High-growth tech companies
- Startups and emerging businesses
- Companies in cyclical industries
- Businesses undergoing major transitions
Sensitive to Input Changes
Small changes in your assumptions can dramatically alter the results. Consider this sensitivity analysis:
| Growth Rate | Required Return | Intrinsic Value (D₁ = $3.18) |
|---|---|---|
| 5% | 10% | $63.60 |
| 6% | 10% | $79.50 |
| 7% | 10% | $106.00 |
A mere 1% change in the growth assumption changes the valuation by 25-33%! This highlights the importance of careful, realistic assumptions.
Doesn’t Work for Non-Dividend Stocks
Companies like Amazon, Alphabet (Google), and Berkshire Hathaway don’t pay dividends. The Gordon Growth Model is completely useless for valuing these types of stocks, regardless of how successful they are.
Ignores Other Value Factors
The model focuses exclusively on dividends and ignores:
- Share buybacks
- Asset values
- Competitive advantages
- Management quality
- Industry dynamics
Mathematical Constraints
Remember: g must be less than r, or the formula breaks. This means you can’t use the model for companies expected to grow faster than your required return, even temporarily.
Gordon Growth Model vs Other Valuation Methods
Understanding how the GGM compares to alternative approaches helps you choose the right tool for each situation.
Gordon Growth Model vs Discounted Cash Flow (DCF)
Gordon Growth Model:
- Simple, requires three inputs
- Focuses only on dividends
- Assumes constant growth forever
- Best for stable dividend payers
Discounted Cash Flow:
- Complex, requires detailed projections
- Analyzes all free cash flows
- Allows varying growth rates over time
- Works for any company with cash flows
When to use each: Use GGM for quick screening of mature dividend stocks. Use DCF for a comprehensive analysis of any company, especially those with changing growth profiles.
Gordon Growth Model vs P/E Ratio
Gordon Growth Model:
- Absolute valuation (determines specific price)
- Forward-looking
- Based on dividend fundamentals
- Requires growth assumptions
P/E Ratio:
- Relative valuation (compares to peers)
- Based on current/past earnings
- Simple to calculate
- Doesn’t require growth assumptions
When to use each: Use P/E ratios for quick comparisons within an industry. Use GGM when you want to determine an actual fair value price target.
Gordon Growth Model vs Multi-Stage DDM
Gordon Growth Model:
- Single constant growth rate
- Simpler calculations
- Less accurate for changing companies
- Conservative assumptions
Multi-Stage Dividend Discount Model:
- Multiple growth phases (e.g., high growth, then stable)
- More complex calculations
- More realistic for many companies
- Requires more assumptions
When to use each: Use GGM for truly stable companies. Use multi-stage models for companies transitioning from growth to maturity.
How to Use the Gordon Growth Model in Investment Decisions
Now that you understand the mechanics, let’s discuss practical application strategies.
1: Identify Suitable Candidates
The Gordon Growth Model works best for:
- Dividend Aristocrats: Companies with 25+ years of consecutive dividend increases
- Utilities: Regulated businesses with stable, predictable cash flows
- Consumer Staples: Companies selling essential products (food, household goods)
- Real Estate Investment Trusts (REITs): Required to distribute most income as dividends
- Blue-chip stocks: Large, established companies with mature business models
These are exactly the types of companies featured in guides about earning passive income through dividend investing.
2: Gather Accurate Data
For current dividend (D₀):
- Check the company’s investor relations website
- Review recent quarterly earnings reports
- Use reliable financial data providers like Yahoo Finance or Morningstar
For growth rate (g):
- Calculate historical dividend growth over 5-10 years
- Review analyst consensus estimates
- Consider the company’s payout ratio and earnings growth
- Factor in industry trends and competitive position
For required return (r):
- Start with the risk-free rate (10-year Treasury yield)
- Add a risk premium based on the stock’s beta and market conditions
- Consider your personal return requirements
- Typical range: 8-12% for dividend stocks
3: Calculate and Compare
Run the calculation and compare the intrinsic value to the current market price:
- Undervalued (>10% below intrinsic value): Potential buy opportunity
- Fairly valued (±10% of intrinsic value): Hold if you own it, wait if you don’t
- Overvalued (>10% above intrinsic value): Consider selling or avoiding
4: Use as Part of a Broader Analysis
Never rely solely on the Gordon Growth Model. Combine it with:
- Price-to-earnings ratio analysis
- Debt levels and financial health metrics
- Competitive positioning and moat strength
- Management quality and capital allocation history
- Industry trends and economic factors
This comprehensive approach aligns with the smart investment strategies that successful long-term investors employ.
Common Mistakes to Avoid
Even experienced investors make these errors when applying the Gordon Growth Model:
1: Using Unrealistic Growth Rates
The error: Assuming a company can grow dividends at 10% annually forever when historical growth is 4%.
Why it’s wrong: No company maintains high growth rates indefinitely. Economic growth, competition, and market saturation eventually slow all businesses.
The fix: Use conservative, historically supported growth rates. When in doubt, err on the low side.
2: Ignoring the g < r Requirement
The error: Trying to value a high-growth company where expected growth exceeds your required return.
Why it’s wrong: The formula produces negative or nonsensical values when g ≥ r.
The fix: Don’t force the model to work for inappropriate companies. Use alternative valuation methods for high-growth stocks.
3: Forgetting to Adjust for Special Dividends
The error: Including one-time special dividends in your growth rate calculations.
Why it’s wrong: Special dividends distort the true sustainable dividend growth pattern.
The fix: Remove special dividends from historical data and focus only on regular quarterly/annual dividends.
4: Overlooking Payout Ratio Sustainability
The error: Assuming dividend growth can continue even when the payout ratio is already 90%+.
Why it’s wrong: Companies can’t pay out more than they earn indefinitely. High payout ratios limit future growth potential.
The fix: Check the payout ratio (dividends ÷ earnings). Sustainable ratios are typically 40-70% for most companies.
5: Not Stress-Testing Assumptions
The error: Running one calculation and treating the result as gospel.
Why it’s wrong: Small assumption changes dramatically affect valuations, as we saw earlier.
The fix: Create sensitivity tables showing how value changes with different growth rates and required returns. This reveals the range of possible values.
Interpreting Gordon Growth Model Results
Once you’ve calculated an intrinsic value, proper interpretation is crucial.
Understanding Valuation Gaps
Small gap (0-10%):
The market price and your calculated value are close. This suggests:
- The market agrees with your assumptions
- The stock is fairly priced
- No urgent action needed
Moderate undervaluation (10-25%):
Your analysis suggests meaningful upside potential. Consider:
- Double-checking your assumptions
- Researching why the market might be pricing it lower
- Gradually building a position
Significant undervaluation (>25%):
Large gaps require skepticism. Ask yourself:
- Are my assumptions too optimistic?
- Does the market know something I don’t?
- Is there a hidden risk (debt, litigation, industry disruption)?
Overvaluation (any amount):
When market price exceeds intrinsic value:
- Avoid buying (if you don’t own it)
- Consider trimming positions (if you do own it)
- Monitor for price corrections
- Recognize that markets can stay irrational longer than you expect
The Margin of Safety Principle
Value investing legend Benjamin Graham emphasized buying with a margin of safety — purchasing only when the market price is significantly below intrinsic value.
Recommended approach:
- Require at least a 20-30% discount for new purchases
- This cushion protects against estimation errors
- Provides room for unexpected company challenges
- Increases long-term return potential
Real Data Example: Analyzing a Utility Stock
Utility companies are ideal candidates for the Gordon Growth Model. Let’s analyze a hypothetical example based on typical utility characteristics.
NextEra Energy (Hypothetical Analysis)
Company profile:
NextEra Energy is one of the largest electric utilities in the United States, known for consistent dividend growth and stable cash flows.
Data inputs:
- Current annual dividend: $1.68 per share
- 10-year historical dividend growth: 10.5% annually
- 5-year historical dividend growth: 9.8% annually
- Current payout ratio: 65%
- Current stock price: $75.00
Determining growth rate:
Given the slowing growth trend and high payout ratio, we’ll use a conservative 7% long-term growth assumption (below recent history but realistic for maturity).
Determining required return:
- 10-year Treasury yield: 4.5%
- Equity risk premium for utilities: 4.0%
- Required return: 8.5%
Calculation:
D₁ = $1.68 × 1.07 = $1.80
Intrinsic Value = $1.80 ÷ (0.085 – 0.07)
Intrinsic Value = $1.80 ÷ 0.015
Intrinsic Value = $120.00
Analysis:
With a current price of $75.00 and an intrinsic value of $120.00, the stock appears undervalued by 37.5%.
Investment decision considerations:
- Significant margin of safety
- Stable industry with regulatory protection
- Consistent dividend history
- Verify assumptions with current financial reports
- Check for industry headwinds (regulatory changes, renewable energy competition)
- Confirm company-specific risks aren’t being overlooked
This type of analysis helps investors identify opportunities in the stock market that others might be missing.
Advanced Considerations and Variations
For investors ready to go deeper, here are some advanced applications.
Adjusting for Inflation
Some analysts prefer to work with real growth rates (inflation-adjusted) rather than nominal rates. This approach:
- Removes the inflation component from both g and r
- Provides clearer insight into actual purchasing power growth
- Makes historical comparisons more meaningful
Formula adjustment:
Real growth rate = [(1 + nominal growth) ÷ (1 + inflation rate)] – 1
The H-Model (Two-Stage Growth)
The H-Model is a variation that allows for gradually declining growth rates:
Formula: Value = [D₀ × (1 + g_L) + D₀ × H × (g_S – g_L)] ÷ (r – g_L)
Where:
- g_S = short-term high growth rate
- g_L = long-term stable growth rate
- H = half-life of the high-growth period in years
This model is more realistic for companies transitioning from growth to maturity.
Incorporating Share Buybacks
Some companies return cash through buybacks rather than (or in addition to) dividends. You can adjust for this:
Total shareholder yield = Dividend yield + Net buyback yield
Use total distributions in your calculations rather than just dividends for a more complete picture.
Gordon Growth Model in Different Market Conditions
The model’s usefulness varies depending on the market environment.
Bull Markets
During periods when the stock market goes up consistently:
- Many dividend stocks become overvalued
- The GGM helps maintain discipline
- Identifies rare undervalued opportunities
- Prevents overpaying due to market euphoria
Bear Markets
During downturns, when people lose money in the stock market:
- Quality dividend stocks often become undervalued
- The GGM highlights compelling buying opportunities
- Providing a rational framework amid fear
- Helps distinguish temporary price drops from permanent impairment
Interest Rate Changes
Rising rates:
- Increase required returns (r)
- Lower intrinsic values
- Make dividend stocks less attractive relative to bonds
Falling rates:
- Decrease required returns (r)
- Increase intrinsic values
- Make dividend stocks more attractive
Understanding these dynamics helps you adjust your analysis for current conditions.
Building a Dividend Portfolio Using the Gordon Growth Model
Here’s how to construct a portfolio using GGM analysis:
Step 1: Screen for Candidates
Criteria:
- Minimum 10 years of dividend history
- Payout ratio below 80%
- Investment-grade credit rating
- Consistent earnings growth
This creates a universe of stable, suitable companies.
Step 2: Calculate Intrinsic Values
Run Gordon Growth Model calculations for each candidate using conservative assumptions. Create a spreadsheet tracking:
- Company name and ticker
- Current price
- Intrinsic value
- Discount/premium percentage
- Dividend yield
- Growth rate used
Step 3: Rank by Opportunity
Sort companies by the size of their discount to intrinsic value. Focus on those trading at least 20% below your calculated fair value.
Step 4: Diversify Across Sectors
Don’t concentrate all holdings in one industry. Build a portfolio with:
- 20-30% Consumer Staples
- 20-30% Utilities
- 15-25% Healthcare
- 15-25% Financials
- 10-20% Industrials
This diversification protects against sector-specific risks.
Step 5: Monitor and Rebalance
Quarterly:
- Update dividend data
- Recalculate intrinsic values
- Trim positions that become overvalued
- Add to undervalued holdings
This disciplined approach, combined with strategies for making passive income, can build substantial wealth over time.
Frequently Asked Questions (FAQ)
There’s no single “good” value — it depends on the current market price. A stock is attractive when its intrinsic value (calculated by the GGM) significantly exceeds its current market price, typically by at least 20-30%. This margin of safety protects against estimation errors and provides upside potential.
The Gordon Growth Model formula is: Stock Value = D₁ ÷ (r – g), where D₁ is next year’s expected dividend, r is your required rate of return, and g is the expected constant dividend growth rate. First, multiply the current dividend by (1 + growth rate) to get D₁, then divide by the difference between your required return and the growth rate.
Don’t use the GGM for: (1) companies that don’t pay dividends, (2) businesses with inconsistent or unpredictable dividend patterns, (3) high-growth companies where g approaches or exceeds r, (4) companies in financial distress, or (5) businesses undergoing major transformations. The model only works for stable, mature, dividend-paying companies with predictable growth.
Yes, the model can produce negative values, which indicates it’s being misapplied. This happens when: (1) the growth rate (g) equals or exceeds the required return (r), or (2) you’re using it for an inappropriate company. A negative value is a red flag that you should use a different valuation method.
Use a conservative, sustainable growth rate based on: (1) historical dividend growth over 5-10 years, (2) the company’s payout ratio and earnings growth potential, (3) industry growth expectations, and (4) economic growth constraints. Most mature companies can’t sustain growth above 6-8% indefinitely. When in doubt, use a lower rate — it’s better to be conservative and pleasantly surprised.
The GGM’s accuracy depends entirely on your assumptions. With realistic inputs for stable dividend stocks, it provides reasonable ballpark valuations. However, it’s not precise and shouldn’t be your only analysis tool. Use it as one input among several valuation methods. Studies show it works best for utilities and consumer staples, less well for cyclical industries.
The Gordon Growth Model is a specific type of dividend discount model (DDM). The DDM is the broader category that includes any valuation method based on discounting future dividends. The Gordon Growth Model is the simplest DDM version, assuming constant perpetual growth. Other DDMs include multi-stage models that allow varying growth rates over time.
Conclusion: Putting the Gordon Growth Model to Work
The Gordon Growth Model is a powerful yet straightforward tool that belongs in every dividend investor’s toolkit. While it has limitations — particularly its assumption of constant growth and inapplicability to non-dividend stocks — it excels at what it was designed for: valuing stable, mature companies that consistently reward shareholders with growing dividends.
Key takeaways to remember:
- Use it appropriately: Reserve the GGM for established dividend payers with predictable growth, not high-growth or speculative stocks
- Be conservative: When estimating growth rates and required returns, err on the side of caution to build in a margin of safety
- Combine with other methods: Never rely on a single valuation approach; use the GGM alongside P/E analysis, DCF models, and qualitative assessment
- Stress-test assumptions: Small changes in inputs dramatically affect outputs, so always run sensitivity analyses
- Maintain discipline: Let the model help you avoid overpaying during bull markets and identify opportunities during corrections
Your Next Steps
Ready to apply what you’ve learned? Here’s your action plan:
This week:
- Identify 5-10 dividend-paying stocks you’re interested in
- Gather their current dividend, historical growth rates, and current prices
- Calculate intrinsic values using the Gordon Growth Model
- Compare results to market prices to find potential opportunities
This month:
- Research companies trading below your calculated intrinsic values
- Verify that your growth assumptions are realistic
- Read company annual reports and earnings calls
- Start building or refining your dividend portfolio
This year:
- Track your GGM calculations and compare to actual stock performance
- Refine your assumption methodology based on results
- Build a systematic process for screening and valuing dividend stocks
- Consider teaching others about the model to deepen your understanding
Understanding valuation fundamentals like the Gordon Growth Model is essential for long-term investing success. It helps you think like a business owner rather than a speculator, focusing on fundamental value rather than price momentum. Combined with other smart financial strategies, this approach can help you build lasting wealth.
Whether you’re just starting your journey to become a successful investor or you’re refining your existing strategy, the Gordon Growth Model provides a time-tested framework for making rational, disciplined investment decisions. The formula is simple, but mastering its application takes practice, patience, and continuous learning.
Start small, be conservative, and let the power of compound growth work in your favor — both in the dividends you receive and in the knowledge you accumulate.
References and Further Reading
To deepen your understanding of the Gordon Growth Model and dividend investing, consult these authoritative sources:
Academic and Professional Resources:
- CFA Institute – Equity Valuation: Applications and Processes – Professional standards for equity valuation
- Investopedia – Gordon Growth Model Definition – Comprehensive explanation with examples
- Morningstar – Dividend Investing Research – Data and analysis on dividend-paying stocks
Regulatory and Educational:
- U.S. Securities and Exchange Commission – Investor.gov – Educational resources on stock valuation and investing
- Federal Reserve Economic Data (FRED) – Economic Research – Historical interest rates and economic data for determining required returns
These resources provide the foundation for credible, evidence-based investment analysis.
Disclaimer:
This article is for educational purposes only and does not constitute financial, investment, or professional advice. The Gordon Growth Model is one of many valuation tools, and no single method should be used in isolation to make investment decisions. Stock values can fluctuate significantly, and past dividend growth does not guarantee future performance.
Before making any investment decisions, consider your personal financial situation, risk tolerance, and investment objectives. Consult with a qualified financial advisor, tax professional, or investment advisor who can provide personalized guidance based on your specific circumstances. The author and publisher assume no liability for any financial losses or damages resulting from the use of information presented in this article.
Investing in stocks involves risk, including the potential loss of principal. Always conduct thorough research and due diligence before investing.
About the Author:
Written by Max Fonji — With over a decade of experience in financial education and investment analysis, Max is your go-to source for clear, data-backed investing education. At TheRichGuyMath.com, Max breaks down complex financial concepts into actionable strategies that help everyday investors build wealth through smart, disciplined decision-making. His mission is to democratize financial knowledge and empower readers to take control of their financial futures.
