Gordon growth price ceiling: valuing a growing dividend
Use the Gordon growth model to estimate a price ceiling from the next dividend, required return, and growth rate, plus a sensitivity table.
The Gordon growth model values a stock as the present value of a dividend that grows forever at a steady rate. The result is a price ceiling driven by only three inputs: next year’s dividend, your required return, and the dividend growth rate.
It is elegant and also fragile: tiny changes in the inputs create huge changes in the answer. This guide shows how to use it responsibly with a sensitivity table. Educational only.
The formula
Price equals next year’s expected dividend divided by the difference between your required return (r) and the dividend growth rate (g). Next year’s dividend, D1, is this year’s dividend times (1 + g).
The model only works when r is greater than g. If growth is expected to match or exceed your required return, the formula breaks down, and it is a sign your growth assumption is unrealistic for a perpetual stream.
Price = D1 ÷ (r − g) D1 = D0 × (1 + g)
A worked example
A utility pays a $2.00 annual dividend. You require a 9% return and expect dividends to grow 4% per year. D1 is $2.00 × 1.04 = $2.08. The price ceiling is $2.08 ÷ (0.09 − 0.04) = $41.60.
Add a 10% margin of safety and the buy limit becomes $41.60 × 0.90 = $37.44. Any price below that implies a required return above 9% if growth is as expected.
Why sensitivity matters
Because the denominator is the gap between r and g, small input changes swing the result. Keep the example dividend at $2.00 and see how the ceiling moves.
- r = 9%, g = 3%: ceiling about $34.33
- r = 9%, g = 4%: ceiling $41.60
- r = 9%, g = 5%: ceiling $52.50
- r = 10%, g = 4%: ceiling about $34.67
How to choose r and g sensibly
For r, use a return that compensates you for risk, often a few points above the 10-year Treasury yield for stable companies. For g, never exceed long-run nominal GDP growth, which is a common ceiling of about 4% to 5% in the US. Better still, base g on the company’s actual dividend growth history and its retention of earnings.
Use the model as a sanity check beside a yield ceiling, not as the sole source. If the two methods disagree by a wide margin, investigate which input is driving the gap.
- Estimate g from the past five to ten years of dividend growth, then haircut it.
- Set r above Treasury yields by a risk premium you can live with.
- Compute D1 and the price, then run the table above with a higher and lower g.
- Use the lowest reasonable result as the starting point for your buy limit.
Keep learning
Stress-test your ceilings
Create a free account to save ceilings and revisit them as dividends and rates change.