Constant growth model

Values a share as next year's dividend divided by the required return less a growth rate assumed to last forever. It works only with growth below the required return, and the value explodes as the two converge.

Where you will meet it

Constant growth model appears in 3 learning outcomes on the CFA syllabus. A few of them:

• Set out what the Gordon growth model takes for granted and how sensitive its output is to inputs
  CFA Level I · Equity Investments

  “The constant growth model assumes dividends grow forever at a single rate strictly below the required return, and that the required return itself is stable.”

• Work out the cost of both common and preferred equity
  CFA Level I · Corporate Issuers

  “The dividend discount approach rearranges the Gordon growth model to give the expected dividend yield plus the growth rate.”

• Set out how an equity risk premium can be estimated from past data or from forward-looking inputs
  CFA Level II · Corporate Finance

  “Forward-looking estimates include surveys, the Gordon growth model (forward dividend yield + expected long-term growth − government bond yield) and the supply-side model, which builds the expected return from expected inflation, real EPS growth, any change in the P/E ratio and the income return, then subtracts the bond yield.”

See also

Required return

Practise it

• Today's practice question One question, with every wrong option explained.
• Free Level I diagnostic test Twelve questions that show which topics to start with.
• Free finance calculators Check your arithmetic on the exam's core formulas.

All terms beginning with C · Glossary