CFA CFA Level 2 Leading P/E derived from Gordon Growth Model

Leading P/E derived from Gordon Growth Model

  • This topic has 1 reply, 2 voices, and was last updated Mar-19 by fabian.
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    • ok27
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      I do not understand how we arrive to the formula. Why do we divide the numerator by E1 only and leave the denominator r-g unchanged. Do you have the demonstration of the formula for me? Many thanks for your help and time.

    • fabian
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      We divide both sides of the formula by E1, rather than numerator and denominator, to my understanding.

      P0 = D1 / (r – g)
      P0/E1 = (D1/E1) / (r – g)

      Where

      • P0 = price/value at period 0
      • E1 = earnings at period 1
      • r = required return
      • g = dividend growth rate

      We leave (r – g) alone because we want to ‘create’ D1/E1, which is the dividend payout ratio, which is (1 – b):

      P0/E1 = (D1/E1) / (r – g)
      P0/E1 = (1 – b) / (r – g)

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