Hi folks,
besides CAPM we can calculate Beta using the Gordon DDM.
The formula is:
(Last Dividend * Dividend Growth Rate)/Share Price + Dividend Growth Rate
I get the first half of the formula. This would make a lot of sense. But I don't get why we simply add the Dividend Growth Rate in the end? I thaught we already factored this in. Why do we swing our hammer and bash it on there as well?
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Sorry for the push, hope you guys don't mind!
The logic of the formula is to arrive at the discount rate at which all future dividends equal the stock price. The first instance of the dividend growth rate (multiplying it by the last dividend) is to calculate the next dividend, and the second instance of the growth rate is to account for all subsequent dividends.
You can think about it as rearranging the formula:
Stock price = next dividend / (discount rate - growth rate)
Which is equivalent to:
Stock price = (last dividend * (1 + growth rate)) / (discount rate - growth rate)
Where the discount rate = cost of equity
Also, note that this is calculating the cost of equity itself NOT the beta (which is a measure of volatility and one component of the cost of equity calculation using the CAPM.
Thank you man, very cool! One advanced question. I would be very interested in the actual derivation of our "magical" formula Present Value = (Cash)/(Discount Rate - Growth Rate)
Do you know where I can read about the derivation and why this equation holds?
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