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Common stock is not so easy to value. The cash flows are not stable or easily identified. One simple model that is sometimes used to value common stock is the Gordon Dividend Valuation Model.
| P0 = |
D1
Ks - g |
|
|
| where: |
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| D1 = |
Dividends Year 1 |
| Ks = |
Investors' required rate of return |
| g = |
Growth rate in dividends |
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D1 would be calculated by multiplying current dividends by (1 + g).
For example, price a share of common stock with current dividends of $5, a dividend growth rate of 3% if the investors' required rate of return is 15%.
| P0 = |
5.15
.15 – .03 |
= $42.92 |
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D1 was found by multiplying the current dividends of $5 by 1.03 (1 + .03).
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