by The Zero Growth Dividend Valuation Model, also known as the Gordon Growth Model, is used to estimate the intrinsic value of a company’s common stock based on the present value of its future dividends. It assumes that the dividends paid by the company remain constant over time, with no growth.
The formula for the zero growth dividend valuation model is as follows:
P = D / r
Where:
P is the current market price of the stock
D is the annual dividend per share
r is the required rate of return on the stock
The required rate of return, or the minimum return that an investor expects to earn from investing in the stock, is typically estimated using the Capital Asset Pricing Model (CAPM).
The zero growth dividend valuation model is based on the assumption that the value of a stock is equal to the present value of its future dividend payments, discounted at the required rate of return. The model assumes that the dividend payments remain constant over time, with no growth or change.
This model is commonly used for mature companies that are not expected to experience significant growth in the future. It is also useful for calculating the value of preferred stocks, which typically pay a fixed dividend.
The main advantage of the zero growth dividend valuation model is its simplicity. It is easy to use and requires only a few inputs, making it a popular tool for valuing mature companies that have a stable dividend payment history. However, it does have its limitations, as it does not take into account factors such as changes in the company’s earnings, financial position, or economic conditions, which can impact the value of the stock.
Assumptions:
- The dividend payment remains constant or grows at a constant rate indefinitely.
- The cost of equity is greater than the expected dividend growth rate.
- All investors have access to the same information and make rational investment decisions.
- The company has a stable dividend payout history and is expected to continue with the same payout policy in the future.
- There are no taxes, transaction costs, or other market frictions.
Uses:
- The zero-growth dividend valuation model is useful for calculating the intrinsic value of a mature company that has reached its maximum growth potential and is expected to have a constant dividend payout indefinitely.
- This model is helpful for long-term investors who seek to invest in companies that pay stable dividends, as it allows them to estimate the fair value of the stock and make informed investment decisions.
- It is also useful for companies to determine the appropriate dividend payout ratio that they can sustain indefinitely, based on their cost of equity and expected growth rate.
