How to Value a Stock

If a stock is assumed to produce a series of periodic growing dividend payments, then it can be valued using the present value of growing perpetuity formula. This formula shows the value today of series of periodic payments which are growing at a constant rate (g) each period. The payments are made at the end of each period, continue forever, and have a discount rate i applied.

Formula

PV = Pmt / (i - g)
Variables used in the formula
PV = Present Value
Pmt = Periodic payment
i = Discount rate
g = Growth rate

How to Find the Value of a Stock

If we treat the payment (Pmt) as the dividend at the end of the first year, the growth rate (g) as the rate at which the dividend grows each year, and the discount rate as the required rate of return for equity investors, then the present value (PV) of these cash flows must represent the price an investor is prepared to pay today for this stock.

This formula is sometimes referred to as the Gordon growth model or Gordon dividend model, and is used to calculate the value of a stock based on future dividends. It assumes that the dividends are paid at the end of every period, and that they grow at a constant rate forever.

Example of how to Value a Stock

Suppose for example, a stock pays a dividend of 1.25 at the end of year 1 and the business plans to increase the dividend by 5% each year. If the investors required rate of return is 12%, then the price they are prepared to pay for the stock is given by the time value of money formula as follows:

Pmt = 1.25 Dividend at the end of the first year
g = 5% Dividend growth rate
i = 12% Rate of return for equity investors
Stock Price = Pmt / (i - g)
Stock Price = 1.25 / (12% - 5%)
Stock Price = 17.86

As investor should be prepared to pay 17.86 for this series of cash flows, and as these represent the stock, the stock price should also be 17.86.

Because of the requirement for a constantly growing dividend payment, the model is best suited to a stable business which is expected to experience steady growth, and to pay out regular increasing dividends to shareholders.

Our stock valuation calculator can be used to carry out the calculations described above, by entering details relating to the dividend, growth rate, and investor return rate.

How to Value a Stock November 6th, 2016Team

You May Also Like


Related pages


financial accounting worksheetjournal entry for prepaid incomehow to calculate days receivable ratiois dividends payable a current liabilityaccounts receivable as collateralformula for fixed assets coverage ratiobook value formula depreciationfifo method calculationcost accounting overheadshow to calculate interest rate implicit in the leaseexcel general ledgerhow to calculate pv of annuityaccrued wages balance sheetdupont chart analysisaccrued interest balance sheetpv of annuity due calculatorfv of annuity calculatorvariance analysis and standard costingrevenue projections templatedebit and credit chartbookkeeping abbreviationannuity future value formulapetty cash assetstock dividends distributablehow to calculate income tax payable on balance sheetformula for accounts receivable daysbank rec templatedupont analysis calculatorfactoring process flowstraight line depreciation calculation formulaformula for fixed costclosing inventory holding periodcompound journal entry definitionnpv tablesperpetual inventory system formulatotal credit sales formulaeffective interest rate calculation in exceldefine debitordouble decline balance depreciationpayroll clearing accountinvoiced definitiondebtors control accountthe first step in the accounting cycle iscash disbursement vouchercalculating bad debt expensehow to record accrued expensesgross margin percentage formulapresent value perpetuity calculatoraccrued interest revenuewhy is prepaid expense an assetsales ledger accountwhat is the controllable margin used forexamples of journalinvestment turnover formulameaning of trade creditorsaccrual and prepayment examplespresent value calculator compounded continuouslygrowing annuity formulahow to make closing entriesdepreciation expense calculatorallowance method write offdirect material cost variancesuspense account accountingexcel fv formulaunearned revenue in income statementaverage accounting return calculatorhow to calculate fixed expensescontribution margin in dollarsexample of cash flow statement analysisinterest on investment journal entrywhat is a compound journal entry in accountingexcel general ledgerunearned rent debit or creditmeaning of payback periodprepayment accountingpetty cash transactions definitionkenexa proveit tutorials