Lesson 4 of 9 · All lessons in this module
  1. Intrinsic value, mispricing and the three model familiesVideo lesson
  2. Dividends, splits, buybacks and the payment timelineVideo lesson
  3. Present value models: DDM and FCFEVideo lesson
  4. Preferred stock and the Gordon growth modelVideo lesson
  5. Multistage dividend discount modelsVideo lesson
  6. Price multiples and the method of comparablesVideo lesson
  7. Integrated cases: why multiples differ, the justified P/E and comparables
  8. Enterprise value multiples, asset-based valuation and choosing a modelVideo lesson
  9. Integrated cases: growth from dividend history, enterprise value and reconciling models

Lesson 4 of 9 · 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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