Gordon Growth Model

 Gordon Growth Model

Gordon Growth model is a version of dividend discount model used for the determination of intrinsic value of the stock(s). This model does not take into account the current market condition. The valuation is based on the future dividend and dividend growth rate means that the model equates the present value of stock(s) to the future dividends. The model is applicable only for those stocks that offer dividend constantly. However, the case of the stocks undertaken for this study does not offer dividend continuously; thus, it is not possible to calculate the intrinsic value of the stock through this model.

Thus, CAPM has been used to decide whether the stocks are overvalued or undervalued based on the difference amid expected and actual return.

If the difference is positive, then the stock is overvalued because they are trading at high price than their intrinsic value. If difference is negative, then the stocks are undervalued because they are trading at low prices than their intrinsic prices. The results showed that the MTFS and Apple are currently overpriced.

i.          Limitations of Gordon Growth Model

The underlying assumption of Gordon Growth Model is it’s the main limitation. The model lies on the constant growth in dividend per share; thus, this model is only restricted to the firms shows stable and constant growth rates in their dividends. However, it is difficult for the firms to show constant growth in their dividends due to the fact of business cycles as well as the unpredictable complications associated with business such as financial issues or other like success. In addition, the model has the issue with the association amid growth rate and discount factor. For instance, if growth rate of dividend(s) is more than required rate of return, the outcome would be negative, which questions the worthiness of the model. Same with the case of similar values of growth rate and RRR as the value of the stock(s) reaches to infinity.

As this model cannot be used for this study because of the unavailability of dividend growth rate. Both stocks do not offer constant growth rate for their dividends.