The Walter Model and the Gordon Model are two popular dividend models used in finance and investment analysis to estimate the value of a company's stock based on its expected dividends. Let's discuss each model in more detail:
1. Walter Model (also known as the Dividend-Discount Model): The Walter Model was developed by James E. Walter in 1956. It focuses on the relationship between a company's dividend policy and its valuation. The basic assumption of this model is that the value of a company's stock is determined by its future dividends.
The formula for the Walter Model is as follows:
P0 = D / (r - g)
Where:
• P0 is the current price of the stock.
• D represents the expected dividend per share.
• r is the required rate of return (cost of equity) for the stockholders.
• g is the expected growth rate of dividends.
The model assumes that the dividend payout ratio (the proportion of earnings paid out as dividends) remains constant over time.
Example for Walter Model: Suppose you are analyzing a company that is expected to pay a dividend of $2 per share next year. The required rate of return (cost of equity) for the stockholders is 10%, and the expected growth rate of dividends is 5%. Using the Walter Model, you can estimate the current price of the stock:
P0 = D / (r - g) P0 = $2 / (0.10 - 0.05) P0 = $2 / 0.05 P0 = $40
According to the Walter Model, the current price of the stock would be $40.
2. Gordon Model (also known as the Gordon Growth Model or the Dividend Growth Model): The Gordon Model was developed by Myron J. Gordon in 1959. It builds upon the Walter Model by incorporating the concept of dividend growth. The model assumes that a company's dividends will grow at a constant rate indefinitely.
The formula for the Gordon Model is as follows:
P0 = D0 * (1 + g) / (r - g)
Where:
• P0 is the current price of the stock.
• D0 represents the current dividend per share.
• r is the required rate of return (cost of equity) for the stockholders.
• g is the expected growth rate of dividends.
The Gordon Model assumes that the dividend growth rate remains constant over time and that the required rate of return is greater than the dividend growth rate.
Both models provide a simplified approach to estimating the value of a company's stock based on its dividend payments. However, it's important to note that these models have limitations and should be used in conjunction with other valuation methods for a comprehensive analysis of a company's stock.
Example for Gordon Model: Let's consider the same company as in the previous example. The current dividend per share (D0) is $2, the required rate of return (r) is 10%, and the expected growth rate of dividends (g) is 5%. Using the Gordon Model, you can estimate the current price of the stock:
P0 = D0 * (1 + g) / (r - g) P0 = $2 * (1 + 0.05) / (0.10 - 0.05) P0 = $2 * 1.05 / 0.05 P0 = $2.10 / 0.05 P0 = $42
According to the Gordon Model, the current price of the stock would be $42.
Please note that these examples are simplified illustrations of the models and may not reflect real-world scenarios accurately. In practice, additional factors and considerations are taken into account when valuing stocks and estimating future dividends.
