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Sum of Perpetuities Method for Valuing Stock Prices

Author

Listed:
  • Christian Brown

    (University of Northern Iowa)

  • Fred Abraham

    (University of Northern Iowa)

Abstract

The Gordon Growth Model is widely accepted in valuing growth stocks. We derive an alternative constant growth model from the present value of a perpetuity equation given an assumption that investors discount a firm’s future retained earnings independently from dividends. In a special case when a firm’s return on equity is equal to the discount rate, this alternative model is equivalent to the Gordon Growth Model. However we show using an empirical test that the alternative model correlates significantly more closely to actual stock prices when a firm’s return on equity differs from the discount rate.

Suggested Citation

  • Christian Brown & Fred Abraham, 2012. "Sum of Perpetuities Method for Valuing Stock Prices," Journal of Economic Insight, Missouri Valley Economic Association, vol. 38(1), pages 59-72.
    • Handle: RePEc:mve:journl:v:38:y:2012:i:1:p:59-72
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    JEL classification:

    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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