Aurora Borealis
1 September 1984 Financial Analysts Journal Volume 40, Issue 5

A Simplified Common Stock Valuation Model

  1. Russell J. Fuller
  2. Chi-Cheng Hsia

A simplified stock valuation model based on the general principle that the price of a common stock equals the present value of its future dividends, the H-model is more practical than the general dividend discount model, yet more realistic than the constant growth rate model. The H-model assumes that a firm’s growth rate declines (or increases) in a linear fashion from an above-normal (or below-normal) rate to a normal, long-term rate. Given estimates of these two growth rates, the length of the period of above-normal growth, and the discount rate, an analyst may use the H-model to solve for current stock price.

Like the popular three-phase model, the H-model allows for changing dividend growth rates over time. The H-model thus yields results similar to those of the three-phase model. But the H-model is much easier to use, requiring only simple arithmetic. Furthermore, it allows for direct solution of the discount rate, or cost of equity, whereas more complicated models can give numerical solutions only through trial and error.

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