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# The dividend growth model is a method to estimate a companys cost of equity.

The cost of
equity is closely related to the company's required rate of return, which is the return percentage a
company must make on business opportunities. Companies use this model to conduct a stock
valuation relating to their stocks' dividends and growth, which is discounted back to todays dollar
value. This allows business owners and managers to use a few basic assumptions to estimate at
what share price a company will earn its required rate of return.
Basic assumptions in the dividend growth model assume a stocks value is derived from a
companys current dividend, historical dividend growth percentage, and the required rate of
return for business investments. Business owners and managers can determine their own rate of
return or use a standard rate from the business environment. Standard return rates can be the
historical return percentage from a national stock exchange or the return rate a company can
earn from investing in other business opportunities.
To calculate the value of a stock based on the dividend using the dividend growth model,
youll need three pieces of information:
1.The current dividend payout
2.The growth rate of the dividend
You can look up the current dividend payout and the growth rate of the dividend online.
The required rate of return is something you decide and the impact it has will be
explained momentarily. The equation for calculating the value based on those three
values is:
Value =

## (Current Dividend * (1 + Dividend Growth))

(Required Return Dividend Growth)

One thing to keep in mind, your required return has to exceed the growth rate of the
dividend otherwise the equation falls apart.

This model is a little tricky because it makes a huge assumption, that you assume
dividends grow at a constant rate forever (in perpetuity), which may or may not be the
case. Its not as crazy an assumption as some other models but you should be aware of
it. There are also the typical risks associated with investing based on dividends, since
they can change at any time. However, it serves as a good data point during your
analysis.
---------------------------------------------------------------------------------------------------------Dividend growth model is a valuation method which takes into consideration dividend per share
and its expected growth. This model assumes that dividends grow at a constant rate in perpetuity.

Thus, it is usually employed during the valuation of companies belonging to for mature and stable
The formula is given by:
Intrinsic Value= Current Dividend* (1+Dividend Growth)/(Required Return-Dividend Growth)

.
The Dividend growth model links the value of a firms equity and its market cost of equity by modelling
the expected future dividends receivable by the shareholders as a constantly growing perpetuity.
Its most common uses are:
(1) Estimating the market cost of equity from the current share price; and
(2) Estimating the fair value of equity from a given or assumed cost of equity.

## Expressed as a formula: Ke = D1/P0 + g

Adalah model valuasi untuk menentukan tingkat dividen per lembar saham & tingkat pertumbuhan
yang diharapkan . Model ini mengasumsikan bahwa tingkat pertumbuhan dividen adalah tetap dan
berulang. Metode ini berguna untuk menilai perushaan dalam indusetri yangs udah stabil yang
memberikan pertumbuhan yang tetap

## Problems with the Dividend Growth Model

There are weaknesses in almost any model, and this one is no different. Dividends do not always
remain the same; they can be cut. Dividend growth is not going to remain constant, and this
model assumes constant growth in perpetuity. In addition to looking at the dividend growth model
of stock valuation, consider a few other factors when making a decision:

History of regularly dividend increases (dividend aristocrats are those that have raised
dividends every year for 25 years)
A dividend adequately covered by earnings

There is no way to completely predict what any investment will do. However, you can do a little
research, and choose stocks that show good promise going forward.

The Dividend Growth Model, also known as the Gordon Model, is a fundamental
analysis methodology for determining the value of a stock or business. This model is
used as a strategy for investment based on the dividend yield. It values a company
based on the dividends currently paid as well as the pattern of dividend growth that the
company has displayed over time. Although not all investors are comfortable with this
strategy, it is an important concept for dividend investors to understand.
Companies with decent average dividend yields and reasonable payout ratios are
thought of as reliable and safe investments that offer income as well as an opportunity
for capital growth. The dividend growth model reflects how a company has performed in
the past.
Since it is just an indicator of past performance, it will not guarantee how a company will
do in the future. However, we can only use the information that we have to make an
informed investment decision. So, in making an investment, the dividend growth model
is a very useful tool for the construction of your portfolio of investments that seek to
provide a growing income stream. However, it is not the be all and end all of due
diligence that should be performed on a company.
To calculate how much a stock is worth based on the dividend
growth model, you will need these three things:
1.)

2.)

3.)

## Your required rate of return.

The current dividend payout and growth rate of a company can be researched online. I
like to use Reuters as they display a lot of dividend information along with the other
necessary financial information.
Your required rate of return is based on personal requirements for return on your
investment capital.
How To Calculate Value Based On The Dividend Growth Model:

1.

Add 1 to the dividend growth rate. For example, if the rate is 12%, add
1 to 0.12.

2.

Multiply the sum with the current dividend payout. For example, if the
payout is \$1.50, multiply that by 1.12 to get 1.68.

3.

Divide the product, 1.68, by your rate of return less the dividend
growth. For example, if your rate if return is 20%, less dividend growth
rate of 12% is 8%. Divide 1.68 by 8% or 0.08 and you get \$21.

The above example values the stock at \$21 based on a 12% dividend growth rate.
Compare this value to the most recent closing price of the stock youre considering. If
the closing price is lower, then the model has indicated that this stock has met your
criteria and is worthy of further consideration.
The dividend growth model relies on variables that can change over time and, as such,
can only calculate how the stock should be valued at the current dividend growth rate.
As we have discovered from the most recent market downturn, dividends do not grow at
a constant rate in perpetuity, so the value that we calculate using the dividend growth
model can change!
Of course, as with any valuation model, there are risks associated with investing based
on purely the dividend growth model. It does, however, provide a good data point for