# Gordon Growth Model

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## Definition of 'Gordon Growth Model'

The Gordon Growth Model (GGM) is a stock valuation model that is used to estimate the intrinsic value of a stock. The model is based on the premise that the value of a stock is equal to the present value of its future cash flows.

The GGM assumes that a stock's cash flows will grow at a constant rate in perpetuity. This growth rate is often referred to as the "g" in the GGM formula.

The GGM formula is as follows:

```
P = D / (r - g)
```

where:

* P = the intrinsic value of the stock
* D = the stock's dividend per share
* r = the investor's required rate of return
* g = the stock's expected growth rate

The GGM is a relatively simple model, but it can be used to provide a rough estimate of a stock's intrinsic value. However, the model does have some limitations.

One limitation of the GGM is that it assumes that the stock's cash flows will grow at a constant rate in perpetuity. This assumption is often not realistic, as most stocks' cash flows do not grow at a constant rate.

Another limitation of the GGM is that it does not take into account the risk of the stock. The GGM assumes that the stock's risk is constant, but this assumption is often not true.

Despite its limitations, the GGM can be a useful tool for valuing stocks. The model can provide a starting point for investors who are trying to determine the intrinsic value of a stock.

Here is a more detailed explanation of the GGM formula:

The first term in the GGM formula, D, represents the stock's dividend per share. The dividend is a cash flow that is paid to shareholders on a regular basis. The dividend is often used as a proxy for the stock's future cash flows.

The second term in the GGM formula, r, represents the investor's required rate of return. The required rate of return is the minimum return that an investor requires in order to invest in a stock. The required rate of return is based on the investor's risk tolerance and investment goals.

The third term in the GGM formula, g, represents the stock's expected growth rate. The growth rate is the rate at which the stock's cash flows are expected to grow in the future. The growth rate is often based on the company's historical growth rate.

The GGM formula can be used to estimate the intrinsic value of a stock by plugging in the stock's dividend, the investor's required rate of return, and the stock's expected growth rate. The intrinsic value of the stock is the value that the stock would be worth if it were to pay a constant dividend and grow at a constant rate in perpetuity.

The GGM is a relatively simple model, but it can be used to provide a rough estimate of a stock's intrinsic value. However, the model does have some limitations. The GGM assumes that the stock's cash flows will grow at a constant rate in perpetuity, which is often not realistic. The GGM also assumes that the stock's risk is constant, which is often not true. Despite its limitations, the GGM can be a useful tool for valuing stocks.

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