Understanding the Sum of Perpetuities Method for Valuing Stock Prices

Dennis Jansen

Journal of Economic Insight, 2013, vol. 39, issue 1, 65-72

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.

JEL-codes: G10 G12 (search for similar items in EconPapers)
Date: 2013
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Persistent link: https://EconPapers.repec.org/RePEc:mve:journl:v:39:y:2013:i:1:p:65-72

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