What are the different variations of the Gordon Growth Model and when do you use a multi-stage DDM?

The Gordon Growth Model (GGM) and its extensions form the backbone of dividend discount models in CFA Level II. The key is matching the model to the company's growth profile.

1. Constant Growth (Basic GGM):

$$V_0 = \frac{D_1}{r - g}$$

Use when: Company has stable, sustainable growth forever (mature utilities, consumer staples).

Example: Meridian Power Corp pays D0 = 3.20, expected growth = 3.5%, required return = 9%. $$V_0 = \frac{3.20 \times 1.035}{0.09 - 0.035} = \frac{3.312}{0.055} = \60.22$$

2. Two-Stage DDM:

High growth for n years, then constant growth forever.

$$V_0 = \sum_{t=1}^{n} \frac{D_t}{(1+r)^t} + \frac{V_n}{(1+r)^n}$$

Where $V_n = \frac{D_{n+1}}{r - g_L}$ (terminal value using GGM)

Example: Trellis Biotech, D0 = $1.50, high growth = 15% for 4 years, then 4% forever. r = 12%.

Year	Dividend	PV Factor	PV
1	$1.725	0.8929	$1.540
2	$1.984	0.7972	$1.581
3	$2.282	0.7118	$1.624
4	$2.624	0.6355	$1.668

Terminal value at Year 4: D5 = 2.624 x 1.04 = $2.729 V4 = 2.729 / (0.12 - 0.04) =$34.11 PV of terminal = 34.11 x 0.6355 = $21.68

V0 = $1.540 +$1.581 + $1.624 +$1.668 + $21.68 =$28.09

3. Three-Stage DDM:

High growth → transition → stable growth.

Use when: Growth doesn't drop abruptly — there's a gradual fade period.

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When to Use Each Model:

Model	Growth Profile	Typical Company
Constant GGM	Stable, mature	Everton Electric (utility)
Two-Stage	High then stable	Novus Pharma (patent expiry)
Three-Stage	High → fade → stable	Cascade Software (maturing tech)

Key Assumptions:

• Growth rate (g) must be < required return (r), otherwise V → infinity
• Long-run g should approximate nominal GDP growth (2-5%)
• Higher sustainable growth requires higher retention ratio and higher ROE (g = b x ROE)

Exam Tip: CFA Level II item sets typically give you a growth profile and ask you to identify the appropriate model. If growth drops abruptly, use two-stage. If there's a gradual decline described, use three-stage or H-model.

Practice multi-stage DDM calculations in our CFA Level II question bank on AcadiFi.