Constant Growth Modeling: The constant growth model is a model that is used to value a stock. This model is different from the price-to-earnings (P/E) model because it looks primarily inward at the firm’s variables, specifically dividends, whereas the P/E model uses the industry P/E ratio. Constant Growth Model The constant growth model is based on all future dividends. Specifically, the model solves for the present value of all future dividends. The formula is as follows: where D is the expected dividend next year. R is the required rate of return as previously computed with the capital asset pricing model (CAPM). G is the growth rate in dividends. Although this valuation model is relatively easy to use, the shortcoming is in the required assumptions. The fact that this model requires dividends limits its availability to price companies that may be less likely to issue dividends, such as smaller companies, companies that are in growth sectors, or companies that are less mature.
- Summer '13