Gordon formula

The Gordon formula is a formula used to calculate the present value of a stock or company as dividends rise . It is named after Albert Hamilton Gordon (1901–2009).

Formula and explanation

The Gordon formula is:

${\displaystyle P_{0}=G_{1}\cdot {\frac {1-b}{k-b\cdot r_{E}}}}$

Here are:

${\displaystyle P_{0}}$: subjective earnings value (market price, market value) of the share in ; If the stock market is efficient, the following applies: the market value of the stock in the earnings value of all future distributions = market value. The price is determined by expectations. In imperfect (information-inefficient) markets, the market value / income value deviates from the price / stock exchange price (passage of time, flow of information). ${\displaystyle t_{0}}$ ${\displaystyle P_{0}=}$ ${\displaystyle t_{0}=}$

${\displaystyle G_{1}}$: expected earnings per share in ${\displaystyle t_{1}}$

${\displaystyle b}$: Retention rate

${\displaystyle 1-b}$: Payout ratio

${\displaystyle G_{1}\cdot (1-b)}$: Dividend in ${\displaystyle t_{1}}$

${\displaystyle k}$: Market interest rate (the rate of return expected by the shareholders that would be achieved with alternative financial investments)

${\displaystyle r_{E}}$: expected return from investing the retained earnings ${\displaystyle b\cdot G_{1}}$

${\displaystyle b\cdot r_{E}}$: Growth rate for earnings, dividends and price

• Profit:

${\displaystyle G_{1}=G_{0}\cdot (1+w)}$

${\displaystyle w}$ = Growth rate

${\displaystyle G_{2}=G_{0}\cdot (1+w)^{2}}$ etc.

• Dividend:

${\displaystyle D_{1}=G_{0}\cdot (1+w)\cdot (1-b)}$

${\displaystyle D_{2}=G_{0}\cdot (1+w)^{2}\cdot (1-b)}$ etc.

A constant future earnings situation is assumed. This allows the share value to be calculated as an infinite pension. In the case of a growth rate above the cost of capital, however, the mathematical invalidity of the Gordon formula points to economic nonsense: a company cannot last for a growth rate that is higher than the growth rate of the economy as a whole. For example, an implicit growth rate and the implicit return on equity can be derived from the Gordon formula.

Individual evidence

1. ↑ Dinstuhl, Volkmar. Group-related company valuation: DCF-oriented group and segment valuation, taking taxation into account. Springer-Verlag, 2003. p. 119
2. ↑ Peter Hasler: Valuing stocks correctly: Theoretical principles explained in practice . Springer Gabler. 2012. ISBN 978-3642320774 . P. 120.

literature

• Gordon, Myron J., and Eli Shapiro. "Capital equipment analysis: the required rate of profit." Management science 3.1 (1956): 102-110.
• Gordon, Myron J. "Dividends, earnings, and stock prices." The review of economics and statistics (1959): 99-105.
• Lergenmüller, Nico. "The Gordon Growth Model and the corporate image on which it is based." (2003).