How To Use Gordon Model To Estimate Reasonably

　　 Valuation For investors, it is undoubtedly a crucial issue. Only after knowing the reasonable price of a stock can we compare it with the current market price, so as to decide whether to hold or sell the stock. Then, how to calculate the stock reasonable valuation? Dividend discount model (DDM) is undoubtedly the most mainstream and the most basic means at present. Most industry analysts also use this as the core means when issuing the analysis report. Therefore, they are used to analyzing the stock price investors by using P / E ratio and market rate. Understanding this model can not only grasp a new pricing method, but also understand the thinking of the analysts, which is undoubtedly of great benefit.

　 from Gordon Model start with

According to different assumptions, there are several formulas for the dividend discount model. Ordinary investors may wish to start with the most commonly used Gordon model (Gordonmodel).

The Gordon model is very simple. There are three variables: the dividend payout (D1), the rate of return on capital (k) and the sustainable growth rate (g) in the coming year. By using the simple formula of these three variables, we can get the reasonable valuation of a stock at present (P0).

For example, if a stock expects to pay dividends of 1 yuan in the coming year, the rate of return for the market to the company is 12%, and the dividend of the company can grow at a rate of 8%. The reasonable valuation of the company is 1 yuan (12%-8%) =25 yuan.

　 The rate of return on capital is difficult to unify.

The formula is simple, but it is not easy to use because the rate of return on capital is hard to determine. The return on capital demanded by the market, or the long term reasonable return of the stock market, the higher the K value, the lower the reasonable value of the final calculation. For mature markets such as the United States, using the historical data of the past more than 100 years, we can get a long-term stock return data, which can be directly used as K. In addition, the use of treasury bonds, time deposits and other risk free earnings data plus risk premium can also be used as another method of calculating K. When the risk premium is fixed, the lower the deposit interest rate is, the lower the calculated K value is, the higher the valuation will be. This is also why interest rate cuts are seen as a good reason for the stock market.

However, since the A share market was born only 20 years ago, the historical data is limited, so when calculating the K value, it has a relatively large elastic space. For example, debbond securities issued a research report entitled "DDM model shows Shanghai Composite Index > 2424 points" in May 20, 2009, in which 9% was used as the lower limit of K value, while the "improved DDM model for China's A share market valuation" issued in July 31, 2008 by the capital securities group considered that the risk premium of A shares was 6% to 8%, plus 4.14% of the one-year deposit interest rate, and then the K value was between 10.14% and 12.14%. {page_break}

Don't underestimate the difference between 1%, or take 1 yuan dividend, 12% capital return rate and 8% perpetual growth as an example. If we use 10% of the capital return rate, we can get 50 yuan valuation, which is two times of 12% times; if 11%, we will get 33.33 yuan valuation, which is higher than the original 25 yuan. This is why the dividend discount model (DDM) appears to be scientific and rigorous, but the reason why it is highly artistic in practice is that the models used by different analysts are consistent, but if there is a slight difference in the assumptions of K or G, the stock price calculated will be very far away.

　　 payout ratio Is the key

With the parameter K finished, the next step is to say that the sustainable growth rate is g. How to estimate the sustainable growth ability of an enterprise? In the dividend discount model (DDM), the standard formula of G is the percentage of net assets return rate after dividend payment, that is, the profit growth of enterprises comes from the reinvestment of retained profits. If we modify the Gordon model formula and divide each side by earnings per share, we can get the formula based on the dividend discount model (DDM).

From the formula, we can see that dividend payout ratio is an important factor affecting the level of P / E. When payout ratio increases, the P / E ratio will increase correspondingly. While the increase in dividend payout ratio will lead to a decrease in the retention ratio, which will further reduce the sustainable growth rate, resulting in a reduction in the P / E ratio.

The dividend discount model (DDM) under the premise of sustainable growth is doubtless simple, but we can see from the formula that the implied condition is k>g, otherwise, the stock price will be negative. In fact, companies with net profit or dividend growth rate exceeding 10% are everywhere, and more than 30% of the high growth stocks are not in the minority. Therefore, the above model is only a basic model, which is only suitable for those enterprises with mature and sustainable growth rate below the rate of return on capital. For high growing company, two or even three stage models are needed. This kind of model formula is rather cumbersome. There is no introduction here. Interested friends can search for relevant information and study it on their own.