This two-stage growth model is split into two stages. The first one is the high growth stage/period and the second one is the stable growth rate period. Initial years tend to be a high growth rate period until the company starts earning a stable and constant rate.
When a company enters into the market with an innovative idea or project, it earns a higher growth rate. However, the moment there is an upgrade to the technology or competition hots up in the industry segment or quota relaxation is there. For any such reason, the unhindered growth of the company takes a halt after the company enters into a period where its earnings grow in a stable manner as long as the company continues to upgrade and remain relevant to the industry.
This model is based on the limited assumption that the value of the stock is equal to the sum of all future dividend flows to investors. That could be loosely indicated as his cash flows from the investments in the form of dividends only. To calculate the value using a two-stage growth model, one has to discount the dividends of all the years of a high growth rate period plus discounted value of dividends of a stable growth rate period. The formula is as follows:
Where D = dividend of different periods (like D0, D1, and so on)
g = higher growth rate
n = number of years in a high growth rate period
gn = growth rate of the stable growth rate period
r = required rate of return
Two Stage Growth Model Calculator
How to Calculate using Calculator?
The user has to enter the following figures into the calculator. This will provide the present value after discounting all the dividends of both time periods (the high growth rate period and the stable growth rate period).
Dividend – The user is supposed to enter the dividend of 0 periods or the base year in the calculator. It will calculate the value of dividends for the rest of the periods. It is denoted by D0. To determine the value of D1, that is, dividend at 1 period, we add the growth rate in D0 by applying the formula: D1 = D0(1+g). For calculating values of D2, D3, and so on, we have to simply compound the growth rate by the number of periods by a similar formula.
High Growth Rate – This is the growth rate of the high growth rate period or the initial period.
Number of Years in High Growth Rate Period – Provide the number of years in the high growth rate period. This means the number of years till the company is expected to earn at a higher-than-normal growth rate.
Growth Rate of Stable Period – This is the rate of earnings of a stable growth rate period. And, it is always less than the rate of high growth rate period.
Required Rate of Return – This is the rate by which dividends are discounted. The most appropriate method to calculate this rate is CAPM.