Can sombody quickly run over how in example 6 Applying the Gordon Growth Model the analyst estimates a growth of 14%? The formula used was:
1.35(1+g)^4= 2.28 so g is 14%
Also, I thought you use the sustainable growth rate in the calculation not the one estimated at 14%
A quick explanation would greatly be appreciated.
Best regards
Casius
Which example? Could you please post the problem?
The gordon model is used to valuate the price of stocks on mature markets because those companies will have a steady performance, so you can assume the dividends of the stock will be practically constant and the growth will be constant as well.
The formula is:
Price = Dividend / ( r - g )
So, if you need the “g” rate, you must solve for g and get:
g = r - D / P
You need, of course, the other variables as given.
The other way is to use the ROE and the retention rate of dividends, i.e. the portion of net earnings that will go back to the company (dont be declared as dividend).
Example:
So if you have a net earnings of 5MM and an average net equity of 80MM you will have a ROE of 6.25%.
Then, the company’s dividend policy is to declare as dividend the 40% of the net earnings. So your retention rate is 60%. To get the “g” rate you multiply both the ROE and the retention rate: g = (6.25%)(60%) = 3.75%
I Hope helped you.