How the Gordon Growth Model works
The model assumes dividends grow at a constant rate g forever, discounted at your required return r. It is a single-stage DCF where cash flow equals the dividend.
When to use it (and when not to)
- Good fit: utilities, consumer staples, telecoms, REITs — steady payout histories.
- Poor fit: growth companies that pay little or no dividend; use a DCF calculator instead.
- The result is extremely sensitive to r − g: a 1-point change in either input can move fair value by 25% or more. Always test a range.
When the Gordon model is the wrong tool
The Gordon Growth Model divides next year's dividend by the difference between your required return and a perpetual growth rate. That structure imposes three hard requirements: the company pays a dividend, the dividend will keep growing, and the growth rate stays below your discount rate forever.
The third one is where most users break it. Set growth equal to or above the discount rate and the denominator goes to zero or negative, producing an infinite or nonsensical value. If your model needs 9% perpetual dividend growth against an 8% discount rate, no dividend stock will ever satisfy it and the model has nothing to say.
The model also assumes a smooth, perpetual growth rate that no real company delivers. Dividends get cut in recessions, frozen in credit crunches and reset after spin-offs. For a company with lumpy or policy-driven dividends, a two-stage model with an explicit high-growth period is more honest — and for a company that does not pay a dividend at all, use free cash flow instead.
Sanity-checking the output
Compare the result against the dividend yield implied by the current price. If the model says a stock yielding 2.5% is worth 60% more than the market pays, it is implicitly assuming dividend growth well above anything the company has achieved. Divide the fair value by the current price to get the implied premium, then ask what growth path justifies it. If you cannot describe that path in one sentence, the inputs are doing the work.
What goes into the discount rate
The required return is what an investor demands for owning this equity at this risk level. For a stable, dividend-paying utility it might be 7%; for a cyclical industrial, 10% or more. There is no "right" number — only the rate at which you, as an owner, would be indifferent between this stock and a comparable alternative. Choosing a discount rate you do not actually believe is the fastest way to produce a valuation that looks rigorous and proves nothing.
DDM versus FCF for dividend stocks
The Gordon model is the cleanest way to think about a stable dividend payer, but it requires a long-term growth assumption that is hard to defend for any single company. Many dividend investors use a discounted free cash flow model and apply a payout ratio to translate FCF into the dividend stream, which gives them an explicit handle on the reinvestment assumption the Gordon model hides. The two approaches converge for a company paying out 100% of free cash flow and diverge when payout is below 100%, which is most of the time.
The discount rate is the whole game
Most of the value the Gordon model produces is sensitive to the discount rate. Move it from 8% to 9% on a stock with 3% growth and the fair value falls by roughly 20%. The difference between a "buy" and a "sell" verdict is usually sitting inside the discount-rate assumption, not the growth assumption. Treat the required return as the most important input you make.
Frequently asked questions
What if the growth rate equals or exceeds the required return?
The model breaks down (division by zero or negative). Practically, no company grows dividends faster than investor expectations forever — lower g or raise r.
How do I estimate the dividend growth rate?
Use the 5–10 year CAGR of dividends per share, then sanity-check it against the payout ratio. A payout ratio already above 80% makes double-digit growth unlikely.
Is my data sent anywhere?
No — all math runs in your browser.