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Understanding the Sum of Perpetuities Method for Valuing Stock Prices

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  • Dennis W. Jansen

    (Texas A&M University)

Abstract

The Sum of Perpetuities Method (SPM) has been introduced as a method of valuing equity, and compared to the Gordon Growth Model (GGM). I point out some features of these two valuation methods, and in particular I show that these two models make different, sometimes implicit, assumptions regarding the firms' earnings reinvestment policies. I also show that firms following the reinvestment policies underlying the SPM grow slower, asymptotically, than firms following the reinvestment policies underlying the GGM. I argue that the choice between using the SPM or GGM to value equity is equivalent to the choice of assumptions about firm behavior with respect to retaining and reinvesting earnings. I also introduce a hybrid model that encompasses both the GGM and the SPM.

Suggested Citation

  • Dennis W. Jansen, 2013. "Understanding the Sum of Perpetuities Method for Valuing Stock Prices," Journal of Economic Insight, Missouri Valley Economic Association, vol. 39(1), pages 65-72.
    • Handle: RePEc:mve:journl:v:39:y:2013:i:1:p:65-72
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    More about this item

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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