You are staring at two dividend stocks. One pays a generous $4 a share but never raises it; the other pays only $2 yet has lifted its payout every year for a decade. The first looks cheaper on dividend yield alone — but the second hands you a growing stream of cash that compounds year after year. What is that growing stream actually worth to you today? The Gordon Growth Model answers with a single division: next year's dividend divided by your required return minus the growth rate. This guide walks through the formula, shows you how to estimate each input honestly, explains why the answer explodes when growth creeps toward your required return, and gives you the two-stage fix for companies still growing fast.
The One-Line Idea: A Stock Is Its Future Dividends, Discounted
Strip away the ticker symbol and the daily price swings, and owning a dividend stock means owning a claim on every dividend the company will ever pay you. A dollar next year is worth less than a dollar today, so each future dividend must be shrunk — discounted — by the return you demand for waiting and for bearing risk. Add up that infinite shrinking stream and you get the stock's intrinsic value: what it is worth to you regardless of what the market charges for it today.
The Gordon Growth Model, named for economist Myron Gordon, handles the special case where dividends grow at one constant rate forever. That single assumption collapses an infinite sum into one line of arithmetic:
P = D1 / (r − g)
In words: fair value equals next year's dividend per share, divided by your required rate of return minus the dividend growth rate. Three inputs, one output. If the model says $53 and the market charges $45, the stock looks undervalued; if the market charges $65, it looks overvalued. The rest of this guide is about earning the right to trust — or distrust — that number.
The Formula, Piece by Piece
Each input answers a different question, and mixing them up is the most common way to misuse the model.
D1: next year's dividend, not this year's
D1 is the dividend you expect to receive one year from now — per share, in dollars. The model discounts from next year onward, so feeding it the dividend the company just paid understates value by a full year of growth. The fix is trivial: multiply the latest dividend (D0) by one plus the growth rate.
D1 = D0 × (1 + g)
A company paying $2.00 today with 6 percent growth gives D1 = $2.00 × 1.06 = $2.12. That $2.12 — not $2.00 — goes into the formula. One multiplication, and you have already avoided the model's most frequent arithmetic error.
r: your required return, the price of your patience
The required return is the minimum annual return that makes holding this stock worthwhile instead of your next-best alternative. It bundles two ideas: compensation for waiting (you could earn the risk-free rate doing nothing) and compensation for risk (this stock can fall). Most investors build it with the Capital Asset Pricing Model: a Treasury yield plus beta times the equity risk premium. For a typical stock today that lands somewhere around 8 to 10 percent a year.
Crucially, r is yours, not the company's. Two investors valuing the same stock with different required returns get different fair values — and both can be right, because each measures value relative to their own alternatives and risk tolerance.
g: the perpetual growth rate, the input that does all the damage
The growth rate g is the annual rate at which dividends grow, forever. Forever is doing heavy lifting in that sentence: the model assumes the company never stalls, never cuts, never gets disrupted, and compounds its payout at g until the end of time. No company literally does this, which is why g must be a modest long-run average — think low single digits for a mature dividend payer — and never larger than the economy's own long-run growth. A company cannot outgrow the world it sells into forever.
A Worked Example in 60 Seconds
Say a steady consumer-goods company just paid $2.00 a share, you expect dividends to grow 6 percent a year indefinitely, and your required return is 10 percent.
D1 = $2.00 × 1.06 = $2.12
P = $2.12 / (0.10 − 0.06) = $2.12 / 0.04 = $53.00
Your fair value is $53 a share. If the stock trades at $45, the model says you are buying a dollar of value for about 85 cents. If it trades at $62, you are paying a premium the dividend stream cannot justify at your required return — pass, or lower the price you are willing to pay.
Notice what the 4 percent denominator means: you are effectively capitalizing the dividend stream at the gap between your required return and growth. That gap is small, which is why the model's output is so sensitive to its inputs — the subject of the next two sections.
Why the Answer Explodes When Growth Nears Your Required Return
Look at the denominator, r − g. As the growth rate approaches your required return, the denominator shrinks toward zero and fair value shoots toward infinity. With D1 = $3 and r = 8 percent, growth of 5 percent gives $3 / 0.03 = $100 — but nudge growth to 7 percent and value triples to $3 / 0.01 = $300. Two percentage points of assumption, three times the valuation.
At exactly g = r, the formula divides by zero: infinite value, which is the math's way of telling you the premise broke. And when g exceeds r, the result goes negative — a stock "worth" negative dollars. Negative value is nonsense, not insight; it means you asked a constant-growth-forever model to price growth that cannot persist forever.
This sensitivity is the model's central warning, not a footnote. Every Gordon Growth valuation should be run as a range, not a point: try growth a point higher and a point lower, try the required return half a point each way, and see whether your buy-or-pass decision survives. If a one-point change in g flips your conclusion, you do not have a valuation — you have a guess wearing a formula's clothes.
Estimating g Without Fooling Yourself
Since g drives the answer, it deserves the most care. Three approaches, from simplest to most grounded:
Historical dividend growth. Compute the compound annual growth rate of the company's dividends over the past 5 to 10 years. This is quick and uses real data, but it projects the past forward — fine for a regulated utility with a 20-year record of 4 percent raises, dangerous for a company whose growth came from a one-time expansion now ending.
The sustainable growth rate. Finance theory offers g = retention ratio × return on equity (ROE). A company earning 15 percent on equity and retaining 40 percent of earnings (paying out 60 percent) can sustainably grow at 0.40 × 0.15 = 6 percent. This ties growth to something observable — profitability and payout policy — rather than to hope. Decompose ROE further and you can see whether growth comes from genuine efficiency or merely from piling on debt.
Analyst estimates, capped by reality. Professional forecasts give a forward-looking view, but analysts skew optimistic. Whatever source you use, cap perpetual growth below long-run nominal GDP growth — typically 3 to 5 percent for a large economy. A mature company growing its dividend 8 percent forever would eventually become the entire economy, which is your cue that the growth rate belongs in a two-stage model instead.
For your required return r, the standard build is CAPM: a Treasury yield for the risk-free rate plus beta times an equity risk premium of roughly 4 to 5 percent. Document each choice — "10-year yield 4.5 percent, beta 1.1, premium 4.5 percent, so r ≈ 9.5 percent" — so future you can see what the valuation assumed.
The Two-Stage Fix for Fast Growers
The single-stage model fails for companies growing faster than your required return allows — which is most interesting dividend growers in their expansion phase. The fix is to split the future in two: an explicit high-growth phase you forecast year by year, plus a stable phase from that point onward valued with the Gordon formula as a terminal value.
The recipe:
- Forecast dividends through the high-growth years and discount each one to today at r.
- Value everything from the stable phase onward with P = D / (r − g_stable), measured at the end of the high-growth phase — this is the terminal value.
- Discount the terminal value back to today and add it to the high-growth dividends' present value.
Work it through: a company just paid $1.00, will grow dividends 12 percent a year for 5 years, then settle to 3 percent forever, with your required return at 9 percent. The five high-growth dividends are $1.12, $1.25, $1.40, $1.57 and $1.76, whose present values sum to about $5.43. In year 6 the dividend is $1.76 × 1.03 ≈ $1.82, so the terminal value at the end of year 5 is $1.82 / (0.09 − 0.03) ≈ $30.25 — worth about $19.66 in today's dollars. Total fair value: roughly $25.09.
Two lessons hide in that arithmetic. First, the terminal value dominates: $19.66 of the $25.09 total comes from the stable phase, so your "stable" growth assumption still decides the answer — the two-stage model disciplines the near term but cannot escape the long term. Second, the length of the high-growth phase is itself an assumption: five years of 12 percent growth is a claim about competitive advantage, and it should come with evidence, not enthusiasm.
Putting the Model to Work in Your Own Books
A valuation only helps if you can compare it against what you actually paid and actually received. If you keep your investing in Beancount alongside the rest of your finances, booking a dividend-stock purchase with its cost basis takes a few lines:
2026-03-10 open Assets:Brokerage:DIVCO
2026-03-10 open Income:Dividends:DIVCO
2026-03-10 * "Buy dividend grower at model price"
Assets:Brokerage:DIVCO 100 DIVCO {53.00 USD}
Assets:Checking -5300.00 USD
2026-06-15 * "Quarterly dividend received"
Assets:Checking 53.00 USD
Income:Dividends:DIVCO -53.00 USDWith purchases recorded at cost and each dividend booked as income, your ledger holds both sides of the Gordon comparison: the price you paid next to the growing payout stream you valued. The Beancount documentation covers price annotations and lot tracking for this kind of investing ledger, and Fava charts dividend income over time so you can watch whether the company's actual raises keep pace with the growth rate your valuation assumed. When the raises stall two years running, the model input — not just the stock price — is telling you to re-run the numbers.
Where the Model Breaks Down
It prices only dividend payers. Growth stocks that reinvest everything, pre-profit companies, and firms returning cash purely through buybacks have no dividend stream to discount. You can sometimes adapt the model to total shareholder payout — dividends plus buybacks per share — but buybacks are irregular by design, which fights the constant-growth assumption.
Constant growth is a fairy tale for most firms. Business cycles, recessions, disrupted industries and management changes all break smooth compounding. The model fits regulated utilities, consumer staples giants and other mature dividend aristocrats far better than cyclicals or turnaround stories. Match the tool to the company, not the company to the tool.
It ignores everything dividends don't capture. Brand strength, hidden assets, net cash piles, and the option value of unlaunched products never enter the formula. A company sitting on a mountain of cash is worth more than its dividend stream alone — value the excess cash separately and add it, rather than pretending the model sees it.
Forever is longer than you think. Discounting an infinite stream gives enormous weight to dividends decades away that neither you nor the company can foresee. The two-stage model helps by quarantining the fantasy in the terminal value, but "quarantined" is not "eliminated" — most of the answer still comes from the far future.
Common Mistakes When You Run It Yourself
Using this year's dividend instead of next year's. D0 in place of D1 understates value by exactly one year of growth. Always grow the latest payout once before dividing.
Letting growth match or beat your required return. If your inputs give g at or above r, stop — the formula cannot price that scenario. Either the growth is temporary (use the two-stage model) or your required return is too low for the risk.
Assuming perpetual growth the economy can't support. A stable-phase g of 7 or 8 percent forever implies the company eventually dwarfs the economy. Keep mature-phase growth at or below long-run nominal GDP growth, and treat anything above 5 percent with deep suspicion.
Mixing nominal and real. If your required return is nominal (it includes inflation, as Treasury yields do), your growth rate must be nominal too. Pairing a real growth rate with a nominal discount rate quietly subtracts inflation from value. Pick one basis and keep all three inputs in it.
Quoting false precision. With g estimated to the nearest point at best, a fair value of $52.87 claims knowledge nobody has. Round to the nearest dollar and think in ranges — "about $48 to $58" is the honest output, and any decision that flips inside that band is not a decision the model can make for you.
Your Next Step
Pick one dividend stock you own or are watching. Find its latest annual dividend, estimate a defensible perpetual growth rate (start with the sustainable-growth formula: retention ratio times ROE, capped near 4 percent), and build your required return from today's Treasury yield plus a beta-adjusted premium. Run the division, then stress it: growth a point higher and lower, required return half a point each way. If the stock's price sits below even your pessimistic value, you may have found a bargain worth researching further; if it only works under your rosiest growth assumption, you have learned something just as valuable — exactly how much optimism the current price demands.
