One method which may be used by the investor in order to evaluate the value of a share is to use the Gordon growth model. The basic assumption of the model is that a share's value is based upon the present value of its future dividend payments, assuming a perpetual rate of growth in dividends and a consistent required rate of return on equity.
Assumptions and Terms of the Gordon Growth Model
The Gordon growth model makes a number of assumptions about a company and its performance, which should be considered before the terms of the equation are deduced. In the first instance, the model assumes that the required rate or return and the growth in dividends are constant. As such these assumptions mean that, the model is best suited to the analysis of longer established enterprises where such assumptions are more likely to hold true to empirical testing.
The assumptions made above also mean that the model is unusable in its simple form, where a company is in its early development stage and thus dividends and growth rates are unstable. The model is also unusable, where a company has not yet paid a dividend such as in the case of Gartmore. Finally the model from a mathematical perspective only works, where the rate of growth is lower than the expected rate of return.