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An investigation of Gordon's common stock valuation model

University of British Columbia

The purpose of this study was to determine whether a model based upon the dividend formulation of Myron J. Gordon provides an adequate explanation of the variation in common stock prices. In particular, the hypothesis tested is that investors mainly consider dividends, the rate of growth in dividends and the risk characteristics of the firms in valuing shares of common stock. The model was tested by using multiple regression analysis on a cross-section of U.S. companies in the machinery industry in each of the years 1956 to 1965. Alternative measures or proxies for "normalized" earnings, growth, business risk and financial risk were used in testing the model. Empirical results supported the proposition that Gordon's model provides an adequate explanation of the variation in stock prices. On average, between 76% and 81% of the total variation was explained by the model over the ten-year period. The R² values for each year ranged between .68 and .90. The coefficients of the dividend, growth and size variables were significant at the 5% level or better in almost all the years tested and except for growth in two years, these coefficients had the sign indicated by the theory. Business risk and financial risk performed poorly as explanatory variables. The coefficients for both variables were not statistically significant at the 5% level in most years and the business risk coefficient frequently did not have the expected sign.

Text

2011-07-21

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http://hdl.handle.net/2429/36232

Business Administration

University of British Columbia

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