The Gordon Growth Model: "A model for determining the intrinsic value of a stock, based on a future
series of dividends that grow at a constant rate. Given a dividend per share that is payable in one year, and the assumption that the dividend grows at a constant rate in perpetuity, the model solves for the present value of the infinite series of future dividends."
"Gordon Growth Model
Stock Price (P) = D / (k-G)
"Where:
"D = Expected dividend per share one year from now
"k = Required rate of return for equity investor
"G = Growth rate in dividends (in perpetuity)
------------
Now, before we jump all over this, consider this:
1. It was developed by a Canadian finance professor (Gordon, of course) in the 1970's ... no doubt not wanting to be overlooked academically during those days of 'random walks' and such, and
2. Variations of this have actually used by people trying to appraise private companies. For some reason, this seems particularly popular with real estate appraisers who sometimes dabble in private business valuations. In this application, they look at 'free cash flow' (including not only normalized capex but the growth in working capital attached to the assumed revenue growth), divided by a growth-adjusted capitalization rate. The 'built-up' capitalization rate would include factors for equity risk. A growth rate of say, 6% or more would be suspect, considering the model's time horizon is infinite. The calculated result would be adjusted for excess cash and debt, to get an equity value.
This methodology supersedes the more usual discounted cash flow models - no need for precise forecasts, terminal values and such. Theoretically, if your multiyear (and terminal) assumptions are for constant growth, without no variation, this yields the same result.
Of course this is all simplistic. It's arguably useful as a reasonability check on other, more considered analyses.
So to answer the original question, if you can assume constant compounded earnings growth forever, and can also assume the market will reward with constant PE's forever, then sure. But of course that's not real-world.
series of dividends that grow at a constant rate. Given a dividend per share that is payable in one year, and the assumption that the dividend grows at a constant rate in perpetuity, the model solves for the present value of the infinite series of future dividends."
"Gordon Growth Model
Stock Price (P) = D / (k-G)
"Where:
"D = Expected dividend per share one year from now
"k = Required rate of return for equity investor
"G = Growth rate in dividends (in perpetuity)
------------
Now, before we jump all over this, consider this:
1. It was developed by a Canadian finance professor (Gordon, of course) in the 1970's ... no doubt not wanting to be overlooked academically during those days of 'random walks' and such, and
2. Variations of this have actually used by people trying to appraise private companies. For some reason, this seems particularly popular with real estate appraisers who sometimes dabble in private business valuations. In this application, they look at 'free cash flow' (including not only normalized capex but the growth in working capital attached to the assumed revenue growth), divided by a growth-adjusted capitalization rate. The 'built-up' capitalization rate would include factors for equity risk. A growth rate of say, 6% or more would be suspect, considering the model's time horizon is infinite. The calculated result would be adjusted for excess cash and debt, to get an equity value.
This methodology supersedes the more usual discounted cash flow models - no need for precise forecasts, terminal values and such. Theoretically, if your multiyear (and terminal) assumptions are for constant growth, without no variation, this yields the same result.
Of course this is all simplistic. It's arguably useful as a reasonability check on other, more considered analyses.
So to answer the original question, if you can assume constant compounded earnings growth forever, and can also assume the market will reward with constant PE's forever, then sure. But of course that's not real-world.
