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Intermediate · Lesson 7 of 9

Dividend discount model and income valuation

6 minute read · By Krishna Avadhani, Vestora Academy · Updated 18 October 2026

For steady dividend payers, the Gordon growth model values a share as next year's dividend divided by (required return minus dividend growth). It suits mature banks, utilities and infrastructure, not fast growers or companies with no dividend.

Dividend safety matters more than headline yield. Check the payout ratio (dividends / earnings), FCF cover, debt, and the dividend history through past downturns. A very high yield is often a warning that the market expects a cut (a "yield trap").

For Australian shares, compare yields on a grossed-up basis that includes franking credits, especially when comparing with term deposits or global shares.

Formula

P = D1 / (r - g)

Key takeaways

  • Gordon model: P = D1 / (r - g).
  • High yield can be a trap; check payout, cash cover and history.
  • Compare franked and unfranked yields on a grossed-up basis.

Check your understanding

1. D1 = $2.00, required return 8%, growth 3%. Gordon value?

  • $25
  • $40
  • $66.67
  • $200
Show the answer

$40. 2 / (0.08 - 0.03) = $40.

2. A share yields 12% when peers yield 5%. The most likely explanation is...

  • It is a bargain for certain
  • The market expects the dividend to be cut
  • It has no debt
  • It is an ETF
Show the answer

The market expects the dividend to be cut. Extreme yields usually reflect expected cuts or falling prices.

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General education only, not financial advice. Examples are illustrations. Rules, tax settings and products change; check official sources.