Equity Valuation Meets the Sigmoid Growth Equation: The Gordon Growth Model Revisited

Abstract

The valuation of equity is a central topic in finance and accounting from many fronts. However, equity valuation is still subjective as different analysts obtain target prices that are not similar despite using the same publicly available information. Growth has a substantial influence on the value of equities when using Gordon Growth Model. Nevertheless, initial high growth and a constant growth to perpetuity assumption whereby a company continues to grow indefinitely is considered to be naive and simplistic. Therefore, this study proposes the use of sigmoid growth curve equation that is expected to better capture practicalities of firm growth. The sigmoid curve consists of lag, exponential, stationary and decline phases. The aim of this study was to provide evidence of sigmoid growth patterns of Johannesburg Securities Exchange listed companies and to propose a model for valuing equities using principles behind the sigmoid growth curve. This has implications for improving accuracy when approximating the value of equities, detecting mispriced stocks and informing buy/ sell decisions. For this purpose, cumulative sustainable growth patterns of 64 JSE listed companies were examined using data from 1994 to 2014, followed by curve fitting to determine whether the profiles were sigmoid. Interestingly, 50% of the firms showed typical sigmoid growth patterns. Ultimately, a model was developed for valuing equities by replacing growth, g, in the Gordon Growth Model with equivalent parameters in the sigmoid equation. In conclusion, the findings of this study accentuate that the Gordon Growth Model for equity valuation must factor in the complex growth parameters of firms in order to circumvent mispricing shares.