Business Valuation Resources Discussion: Gordon Model

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Business Valuation Resources Discussion:
Gordon Model
Question
Comment
I have posted my comment on the above Business Valuation Resources Discussion as follows:
Gordon Growth Model (GGM) is a perpetuity method and in many cases, we can’t easily apply a
perpetuity method into a finite stream of cash flows in the explicit forecast horizon. Technically,
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this is not correct. And as it is a perpetuity method, GGM application requires that the required
rate of return and growth rate should reflect long-term expectations. This will necessitate us to
see that when we forecast the earnings growth rate much higher than the economy’s nominal
growth rate (see the reason behind this in many standard valuation guide), we need to consider
using multi-stage Dividend Discount Model, instead of GGM.
Historically GGM was developed to value a stable growth and dividend-paying stock in
companies in which we could see a consistent relationship between the dividends and its
profitability.
Reading Mike’s comments, I concur with him in the sense that there have been a couple of
papers criticizing using the FCF with “excess cash” (usually recorded under short-term
investments in marketable securities) assumed as a “distributable cash flow”, which in fact, we
see that “distributable cash flow” has never been distributed and moreover, in certain cases, it is
used for legal settlement, acquisition, etc. See papers by CA Magni/Ignacio Velez-Pareja with
regards to this alternative view.
Back to the above question, as the devils are in the details, then somehow we need more info
about how you got your cost of equity and growth rate, instead of challenging the GGM. There is
nothing wrong with this model as long as the underlying assumptions are satisfied.
Source:
https://www.linkedin.com/groups/1888911/1888911-6075521454311485442 (this link is still
being re-activated upon my access on 6 December 2015)
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