thoughthecaponthegrowthratemaybethenominalgrowth
rate ofthe economy,analysts mayuse growth ratesmuch
lower than this value for individual companies.
3.Thereisanotherinstance inwhich ananalystmaystray
fromastrictlimitimposedonthestablegrowthrate.Ifafirm
islikelytomaintainafewyearsofabove-stablegrowthrates,
anapproximatevalueforthefirmcanbeobtainedbyaddinga
premiumtothestablegrowthratetoreflecttheabove-average
growthintheinitialyears.Eveninthiscase,theflexibility
thattheanalysthasislimited.Thesensitivityofthemodelto
growth impliesthat thestable growthrate cannotbe more
than0.25percentto0.5percentabovethegrowthrateinthe
economy.Ifthedeviationbecomeslarger,theanalystwillbe
better served using a two-stage or three-stage model to
capture the “supernormal” or “above-average” growth and
restricting the Gordon growth model to when the firm
becomes truly stable.
Theassumptionthatthegrowthratein dividendshastobe
constant over time is a difficult assumption to meet,
especiallygiventhevolatilityof earnings.If afirmhasan
averagegrowthratethatisclosetoastablegrowthrate,the
modelcanbe usedwithlittle realeffecton value.Thus,a
cyclicalfirmthatisexpectedtohaveyear-to-yearswingsin
growthrates,buthasanaveragegrowthratethatis 3 percent,
can be valued using the Gordon growth model without a
significantlossofgenerality.Therearetworeasonsforthis
result. First, since dividends are smoothed even when
earningsarevolatile,theyareless likelyto be affectedby
year-to-year changes in earnings growth. Second, the
mathematicaleffectsofusinganaveragegrowthraterather
than a constant growth rate are small.