Gordon's model

An easy way to calculate a price target or an equity value of a share is to use Gordon's model and calculate a value based on profits or dividends.

Gordon's model is named after Myron J. Gordon, who along with Eli Shapiro published this model for valuation of businesses and shares in 1956. Gordon's model is also called the Gordon growth model because it is possible to take growth in earnings or dividend growth into account in the valuation.

The Gordon growth model estimates a price target based on earnings per share, a discount rate and profit growth. A yield-value is based on the assumption that a company lives forever and that the growth that is assumed in the calculation continues in eternity. A yield-value calculation means that earnings far ahead in the future has a very small impact on the present value if the required rate of return not is very low.

The profit growth assumed in Gordon's model can never be higher than the required rate of return and the assumed growth should be an estimate of the average geometric growth over a very long time. When calculating a yield-value for a mature company you probably assume that growth in earnings is around zero.

The required rate of return and the assumed profit growth shall be specified in real terms, you should not include any inflation compensation in required rate of return and profit growth. The reason that the required rate of return and earnings growth to be real is that the estimated earnings is specified in a present value.

Gordon's growth model can be based on profits or dividends, the required rate of return used in the model can be calculated using CAPM.

Yield-value = EPS / (required rate of return - earnings growth)
Yield-value = Dividend per share / (required rate of return - dividend growth)