H-Model Example with United Postal Service These excess dividends over and above the long-term growth rate are then once again divided by the cost of equity capital/investors’ required return minus the long-term growth rate in perpetuity. It assumes that the short-term growth rate transitions to the longer-term rate by using the half-life of the transition period. #2) The Transitory Growth Phase: This adds the excess growth of the dividend amount which is over and above the long-term rate. Return minus the long-term growth rate in perpetuity. Rate and then divides it by the cost of equity capital/investors’ required It takes the previous year’s dividend brought forward by the long-term growth Terminal growth calculation which forms the core base of the H-Model valuation. #1) The Gordon Growth Model (GGM): This is a single-phase, The H-Model formula can be broken down into two parts which are then added This is because new product or services will eventually become widely adopted and competitors will enter the space to get their piece of the market and will spend more money to improve their competitive positioning.Īs such, long-term growth rates should be conservative and my rule-of-thumb is that they should generally not exceed 3% which represents the long-term potential growth rate of GDP. The reasons for this differentiation between short and long-term growth is that outsized growth being generated from new product or service offerings, first-mover advantages, and even competitive advantage, tend to be transient. The H-Model is a perfect tool for transitioning from a period of high growth in the short-term to a sustainable long-term growth rate. While investors should give a company credit for strong growth in the short-term, it is hard to justify using a growth rate above potential GDP growth in the long-term. We will then jump into a real-life example using United Postal Service (UPS) who is currently experiencing outsized growth due to the boom in deliveries associated with e-commerce. This lesson will discuss the reasons for using the H-Model as well as the calculation and inputs used in the formula. Unlike a two-stage DDM which instantly changes growth rates, the H-Model DDM allows for a more realistic gradual transition from the short-term growth rate to the long-term sustainable growth rate. The H-Model is a popular variation of the classic Gordon Growth Model (GGM) that allows for short-term growth rates in the dividend to be factored in on top of the regular terminal value as calculated with the GGM and its assumed growth rate in perpetuity. The end result is a Net Present Value (NPV) calculation of the future dividends of the company. As a type of Dividend Discount Model (DDM), the H-Model is a valuation tool that has its core methodology based on discounted cash flows, which are approximated here with dividends.
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