Types of Growth Model:
1. Gordon Growth Model
2. Stock Valuation Model
3. Discount Cashflow Model
4. Free Cash Flow Model
5. Dividend Growth Model
6. Dividend Discount Model
7. Multi-stage Dividend Discount Model
Here we will explain briefly about types of growth model
Gordon Growth Model:
The Gordon growth model is also called a dividend discount model. It will help to use to determine the intrinsic worth of stock supported a future series of dividends that grow at a continuing rate. Most of the investors can compare companies against other industries in a simple method. These are one of the types of growth models in the stock.
The formula of the Gordon growth model calculator
For example, company A is listed at $15 per share. In that, the company makes a necessary rate of return of 10%. The company pays a dividend at 2% per share for following the year. The investors thinking that it will grow 5% annually. By this, we have to do the Gordon growth model calculator by the formula.
Here p= current stock price
D1=expected annual dividend per following year
k= rate of return
g=growth rate than expected
Formula, p=D1/(k-g)= 2(0.1-0.05) = $40
Stock Valuation Model:
A company of a common stock share of value in determining this process is called stock valuation. This common stock share value has two types. Absolute valuation and Relative valuation. These types of growth models.
The main purpose of the stock valuation method is to find out the company valued and undervalued stocks and company potential growth and overweight and underweight them in an investment. First, we will discuss discounted cash flow or absolute valuation. The valuation will find the essential value of the stock which is discounting the future cash flow of rate which affects the risk from inherent in the stock. it is called a discounted cash flow approach. These are some of the types of growth models.
Discount Cashflow Model:
The absolute valuation methodology attempts to meet a stock’s intrinsic value by decreasing actual money flows at a discount rate which shows the stock’s inherent risk. The discounted cash flow valuation model includes constant growth dividend discount method, multi-stage dividend discount model and free cash flow models.
Single-stage dividend discount model:
The constant growth dividend discount model (DDM) (also known as the single-stage dividend discount model or the Gordon Growth Model) is ideal for appreciating a minority stake in mature dividend-paying companies. Under the DDM, stock value is equal to the discounted present value of dividends per share set to increase at a constant rate.
Stock Value = D0 × (1 + g)/r-g
Multi-stage dividend discount model:
The model has some initial period for the growth of their companies which are expected value of minority stake within long term stabilization. The dividend per share is calculated actual rate growth rate of initial years, the value of stock end of initially high growth period is using the single-stage dividend growth model.
Stock Value =D1+D2+….+Dn+Vn/(1 + r)1(1 + r)2(1 + r)n(1 + r)n
Here D1, D2, D3, Dn is the dividend per share at the end of 1,2,3,4 and Vn is called terminal value.
Free Cash Flow Model:
The value of a minority is controlling ownership based on the free cash flow of a company in which cash flow operating activities less any expected in working capital less any expected capital expenditure. At the end of year 1, the single-stage free cash flow model discounts that the expected cash flow is called a weighted average cost of capital.
Stock Value = FCF1/WACC − g
Here, FCF1 is the free cash flow at the end of 1 year. WACC means the weighted average cost of capital and g is the growth rate of free cash flows.
The stock value depends upon the market value of comparable stocks. This mainly comparable with other companies’ prices to earning ration, book ratio, sales ration, etc. Here the relative valuation means multiplied with earnings per share, sales per share, book value for a share company. The valuation of all stock relative value. This is a type of growth model.
Dividend Growth Model:
This calculates the value of the stock, provided that the dividends rise at a stable rate or different prices during the lifetime of maturity. By calculating the dividend growth model then once we calculate fair value, our investors will compare the fair value with their current equity.
Their particular equity is overvalued or undervalued. then our investors can decide that the equities want to sell or buy their portfolio’s total returns. By this model, we can assume the rate of future growth of dividend distributions. This distribution can give a constant growth rate in the maturity period or different rates of a given period under consideration.
Here p = D1/(k-g)
Where p = fair value price per share that the company issued value of a share.
D = expected dividend per share one year from the present time
g = expected the dividend growth rate
k = required a rate of return
Now we will take an example:
Kavya wants to calculate the fair value of company stock using this method. Company A is a leading retail company, so that declares the annual dividend $5.25 per share in 2015. She wants to see the historical performance, Kavya was estimated to suppose the company dividend will grow at a rate of 3% in a particular period. She also supposes that RRR based on company fundamentals and historical date 15%.
p = D1/(k-g) = $5.25/(15%-3%) = $5.25/12% = $41.70
It is very easy to understand and use. This is only applicable for current paying dividends by the company. The dividends growing at a reasonably constant rate not applicable.
Dividend Discount Model:
Here dividend discount model method is used to say the company stock price that is based on present-day price is the cost of all future dividend payments when discounted back to their present value. By calculating this method, they can get the company cost of capital and value of next year’s dividend.
This model is based on the value of a company is the present worth of the sum of all its future dividend payments. But the company do good produces goods or offer service to earn profits. This is the different types of growth model in the stock.
DDM Formula –
value of stock = excepted dividend per share/(cost of capital equity-dividend growth rate)
value of stock = D/(r-g)
Problems with the Dividend Discount Model:
The few flaws are nothing worth in the dividend discount model. In they increase a constant rate forever without assumes the dividend. We don’t want to do it usually because it will increase every year. The model did not allow the exciting value of non-dividend stocks.
Advantages and Disadvantages of DDM:
If the investors know, the calculation of the value of shares in stock and also a different model to calculate the value of a share. It only takes a little bit of algebra. The sound and logical basis for the model is based on investor purchasing of stock and they can get in the future. the investor can purchase stock security, This basis correct. If the investors looking best price in stocks, Then they can rearrange the process for dividend growth rates than what they are expected from their company. This is very useful to know the predicted value of a share in stocks.
The model will be decided on the concept of the investor’s stock that is likely paying them most. Some of the investors in India behave the investors purchase stocks for reasons that have nothing to company financial position. Some of the people are investing that the company will be more glamorous and interesting. This explains the discrepancy between stock value and actual market value. This model is very useful to investors. It is very difficult to know the accurate results. Companies are changeable with their dividends, This model is difficult. Investors mainly concentered with dividends, but here all owned by the investors. Dividends represent only the share of income a company chooses to payout. Investors still owe retained income and still count towards their wealth.
Multi-Stage Dividend Discount Model:
In the previous was have learned about the dividend discount model for using the calculation value of a stock using future cash flows. But in reality, it will be may not be the case. Here we many companies have experienced high growth after a few years the growth rate may fall into a lower sustainable rate. In that case, we cannot apply the simple formula like the Gordon model. The main concept of the multistage model will be the same as the constant growth model. In that, we provide intrinsic value on that place present value of expected features cash flow of stock. This is different types of growth model in the stocks
V0 = D1/1+K +D2/(1+k)2+….+ Dn/(1+k)n+ Pn/(1+k)n
Pn = Dn+1/k-g.
These are the different calculations of the value of stocks in the growth model and with their formulas.