Gordon growth model
Principles of Finance glossary · Valuation of Bonds & Stocks
Definition
The constant-growth form of the dividend discount model: P_0 = D_1 / (r - g), where g < r and dividends grow at a constant rate g in perpetuity.
Gordon growth model in plain English
Imagine a stock that pays you a cash dividend every year, and that dividend grows a little each year forever. The Gordon growth model asks: what is a fair price to pay today for that endless, growing stream of cash? The formula P_0 = D_1 / (r - g) says the price equals next year's dividend divided by the gap between the return you demand (r) and the dividend's growth rate (g). The intuition: a bigger gap means the payments feel less valuable relative to what you want, so you'll pay less — and growth must stay below your required return (g < r), otherwise a stream growing faster than you discount it would be worth infinity, which makes no sense.
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