Understanding the Sum of Perpetuities Method for Valuing Stock Prices Academic Article uri icon

abstract

  • The Sum of Perpetuities Method (SPM) has been introduced as a method of valuing equity, and compared to the Gordon Growth Model (GGM). I point out some features of these two valuation methods, and in particular I show that these two models make different, sometimes implicit, assumptions regarding the firms' earnings reinvestment policies. I also show that firms following the reinvestment policies underlying the SPM grow slower, asymptotically, than firms following the reinvestment policies underlying the GGM. I argue that the choice between using the SPM or GGM to value equity is equivalent to the choice of assumptions about firm behavior with respect to retaining and reinvesting earnings. I also introduce a hybrid model that encompasses both the GGM and the SPM.

published proceedings

  • The Journal of Economics

author list (cited authors)

  • Jansen, D. W.

complete list of authors

  • Jansen, Dennis W

publication date

  • January 1, 2013 11:11 AM