In the Gordon Growth Model, what does 'r' represent?

In the Gordon Growth Model, 'r' stands for the discount rate, which is a crucial component for calculating the present value of future cash flows, specifically dividends. The model is used to determine the intrinsic value of a stock based on the assumption that dividends will grow at a constant rate indefinitely.

The discount rate reflects the required rate of return that an investor expects from an investment in the stock; it accounts for the time value of money and the risk associated with the investment. This rate is used to discount future dividends back to their present value, allowing investors to assess whether the stock is overvalued or undervalued in comparison to its current trading price.

Understanding the role of the discount rate is essential for effectively applying the Gordon Growth Model, as it directly impacts the valuation calculation. If the chosen discount rate is too high, the present value of future dividends decreases, which may lead to undervaluing the stock. Conversely, a lower discount rate would increase the present value, possibly leading to overvaluation. Therefore, getting 'r' right is critical for accurate stock valuation within this model.