Dividend growth model

The dividend growth model, often referred to as the Gordon model after its creator, understands the value of a company as the present value of all dividends expected in the future.

It is assumed in the model that the expected dividends grow from year to year at a given and therefore known rate. The value of the company therefore depends considerably on the rate of growth. The approach proposed by GORDON in 1962 is based on three assumptions:
1. The first concerns the valuation model: The value of a stock or a company should be equal to the present value of all future dividends.

2. Eine Company valuation wäre demnach einfach, wenn alle zukünftigen Dividenden bekannt wären. Nun gibt es aber Unsicherheit über die Höhe der zukünftigen Dividenden. Um eine Aktie oder eine Unternehmung zu bewerten, müßten Erwartungen hinsichtlich aller zukünftigen Dividenden im einzelnen gebildet werden. Solche Prognosen sind in der Praxis nicht möglich, weshalb zur Vereinfachung eine zweite Annahme getroffen wird. Sie postuliert ein geometrisches Wachstum der Dividendenerwartungen.

3. Die dritte Annahme betrifft die anzuwendenden Diskontfaktoren. Der für die Diskontierung verwendete Cost of capital er soll die Unsicherheit im Hinblick auf die Dividendenhöhe reflektieren soll bekannt und konstant über die Zeit hinweg sein.

In the course of the years t = 1, 2, ... the current dividend "d" multiplied by the factor (1 + g) (where "g" denotes the growth rate) should determine the expected value of the next (still uncertain) dividend.

The dividend growth model underscores two points that have shaped the thinking of analysts:
1. If, from the point of view of the information available at time “t”, expectations are formed with regard to the next dividend, then reports about changes in the dividend amount “fully affect the value”. Because it is assumed in the Gordon model that the changes "propagate" for the future. This fact shapes the thinking of analysts and shareholders: Changes in earnings (or dividends) compared to expectations result in significant price changes.

2. The share price reacts very sensitively to changes in the comparative return “r” or the growth rate “g” if both parameters are close to one another. That is the case with growth stocks. In other words, analysts react strongly with buy or sell recommendations when there are suspicions about possible dividends. Even if there is a change in the difference (r - g), which is considered permanent, the value of the company changes considerably.
DCF method.

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