Hello everybody,I have a question about the dividend growth rate, according to Gordon's dividend discount model, the price of an equity can be calculated as:P = D/(k-g) where P is the price of the stock, D the next period dividen payment (a known constant), k is the equity discount rate, and g is the dividend growth rateMy question is how do you compute the dividend growth rate ?Many thanks for the help.

its up to you how you do that. if you are looking at single equity then you could use historical gowth rates .. if you are looking at a broad market it is generally thought that dividends growth at the rate of GDP because companies have a share of GDP and its growth etc. In general though, the DDM is more useful in informing you about the equity discount rate or the equity risk premium.

One textbook approach to deriving g is taking the product of return on equity and the firm's reinvestment (or 'plowback') rate. If, e.g., a company is getting a 14% return on its invested capital, and it's paying out 30% of its earnings as dividends (hence plowing back 70%), you might figure the dividends to grow at g = 0.14 x 0.70 = 9.8%.Of course with this approach, indeed as with Gordon itself, you need to be keenly aware of the underpinning assumptions, and to what extent they might (will?) fail to hold in the real world. Particularly for a stable biz in a mature industry, Daveangel's growth ≈ GDP would likely keep you from a mis-estimation that was textbook perfect yet still flew off the rails thanks to silly assumptions.

There is no hard and fast rule as to how the perpetuity growth rate is calculated. What LochWulf suggests is what is called in textbooks as the Sustainable Growth Rate, which is ROE * b in the case of equity, where ROE is the Return on Equity and b is the plowback ratio (i.e., 1 - Dividend Payout). If you have publicly-traded equity, you can solve for the implied perp growth rate given all the other inputs. However, because this is a growth rate that you assume will go on into perpetuity, you cannot have g > k. Two rules of thumb suggested in the literature is that g < expected long-term GDP growth rate or g is equal to the risk-free rate used in the discount rate (read Damodaran's Investment Valuation book for more details).

Thank you all for your help.