Lesson 4 of 11 · All lessons in this module
  1. Present value models: DDM and FCFEVideo lesson
  2. Choosing the cash flow: dividends or FCFE
  3. FCFF, EBITDA and residual income
  4. Preferred stock and the Gordon growth modelVideo lesson
  5. Multistage dividend discount modelsVideo lesson
  6. Growth assumptions for any cash flow: constant, implied and two-stage
  7. The DCF process: discount rates, terminal values and ranges
  8. Integrated cases: negative growth and reconciling FCFE with FCFF
  9. Integrated cases: two-stage FCFF with debt, and the effect of the debt ratio
  10. Shortcomings of constant and multistage growth models
  11. Preferred shares: required return and contingency features

This lesson is part of the 2027 curriculum. You are following the 2026 curriculum, where it is not taught in this form. Switch if you are sitting the exam under the 2027 curriculum.

Lesson 4 of 11 · 15 min

Preferred stock and the Gordon growth model

A perpetual preferred share is a perpetuity worth D/r, and a common share with dividends growing at a constant rate forever is a growing perpetuity worth D1/(r−g)D_1/(r-g).

In short

  • Non-callable, non-convertible perpetual preferred: V0=D/rV_0 = D/r. With a maturity: price it like a bond, using par value at maturity.
  • A call option (issuer's) lowers a preferred's value to the investor; a retraction (putable, put) option raises it.
  • Gordon growth model: V0=D0(1+g)/(r−g)=D1/(r−g)V_0 = D_0(1+g)/(r-g) = D_1/(r-g). Needs r>gr > g; uses the next dividend.
  • Best for mature, dividend-paying companies that are insensitive to the business cycle and have a stable dividend growth record.
  • Sustainable growth: g=b×ROEg = b \times ROE, where b = 1 − payout ratio.
  • Value is very sensitive to r and g: small input changes move it a lot.

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