Gordon Growth Model: Formula, Example, and Limits

The Gordon Growth Model — also called the constant-growth dividend discount model — estimates what a stock is worth based on its dividends. It assumes the dividend grows at a steady rate forever and values the share with one compact formula: P = D₁ / (r − g). This guide covers the formula, a worked example, the assumptions behind it, and where it works and where it breaks. To run it on your own numbers, use the dividend discount model calculator.

The formula

P = D₁ / (r − g)

• P — estimated fair value per share
• D₁ — the dividend expected one year from now
• r — your required rate of return (as a decimal)
• g — the constant annual dividend growth rate (as a decimal)

The whole model rests on one relationship: a stock is worth next year's dividend, divided by how much your required return exceeds the dividend's growth rate.

A worked example

Say a stock will pay a $2.00 dividend next year, you require an 8% return, and you expect the dividend to grow 3% a year forever:

P = 2.00 / (0.08 − 0.03) = 2.00 / 0.05 = $40 per share

If the stock trades below $40 on these assumptions, the model calls it undervalued; above $40, overvalued.

The assumptions it relies on

The elegance comes at the cost of strict assumptions:

1. The dividend grows at a constant rate, forever. One rate, indefinitely.
2. The required return exceeds the growth rate (r > g). Otherwise the math breaks (see below).
3. The company pays — and will keep paying — a dividend.

Where it breaks down

• If g ≥ r, the denominator is zero or negative, giving an infinite or negative value — meaningless. The model cannot handle a growth rate at or above your required return.
• High-growth or no-dividend companies don't fit the constant-growth assumption at all.
• Erratic dividends make a single "forever" growth rate unrealistic.

When to use it

The Gordon Growth Model suits mature, stable dividend payers with a long, predictable growth record — utilities, consumer staples, and many dividend aristocrats. For those, it's a quick sanity check on valuation.

To apply it, you need a realistic g — measure a company's actual dividend growth with the dividend growth rate calculator — then drop your inputs into the dividend discount model calculator to get the fair value without doing the arithmetic by hand.

This article is for educational purposes only and is not financial advice. A model is only as good as its assumptions.