Insummary,theGordongrowthmodelisbestsuitedforfirms
growingataratecomparabletoorlowerthanthegrowthrate
in the economy and that have well-established dividend
payoutpoliciesthattheyintendtocontinueintothefuture.
Thedividendpayoutofthefirmhastobeconsistentwiththe
assumption of stability, since stable firms generally pay
substantial dividends.
1 Inparticular,thismodelwillunderestimatethevalueofthe
stock in firms thatconsistently pay out lessthan theycan
afford and accumulate cash in the process.
ILLUSTRATION 5.1: Valuation with Stable-Growth
Dividend Discount Model: JPMorgan Chase—November
2005
JPMorgan Chase has large stakes in both commercialand
investment banking. In recent years, the firm has grown
through acquisitions, some of which it has had problems
digesting.Inthemostrecentfiscalyear,thefirmpaid$1.36in
dividendsper share on earningsper share (EPS)of $2.08,
resultinginadividendpayoutratioof65.38%.Ifweassume
thatthefirmwillmaintainits11.16%returnonequityfrom
the most recent year in perpetuity, we can estimate an
expected growth rate in earnings per share:
Assumingabetaof0.8forthefirm,basedonthebetasof
largecommercialbanks,witharisk-freerateof4.5%andrisk
premium of 4% results in a cost of equity of 7.7%: