This free online Stock Price Calculator will calculate the most you could pay for a stock and still earn your required rate of return -- all based on the current dividend and the historical growth percentage.
Plus, as of August 4, 2016, the calculator also shows its work (step-by-step display showing how it arrived at the stock price).
The common stock valuation formula used by this stock valuation calculator is based on the dividend growth model, which is just one of several stock valuation models used by investors to determine how much they should be willing to pay for various stocks.
The dividend growth model for common stock valuation assumes that dividends will be paid, and also assumes that dividends will grow at a constant pace for an indefinite period of time. Of course, neither of these assumptions rarely, if ever, occur in real life.
To determine the value of a common stock using the dividend growth model, you first determine the future dividend by multiplying the current dividend by the decimal equivalent of the growth percentage (dividend x (1 + growth rate)).
Lastly, the future dividend is divided by the difference between the decimal equivalent of expected rate of return and the decimal equivalent of the growth percentage (future dividend ÷ (expected rate of return - growth rate)).
Unlike bonds, where the risk of principal loss is minimal and dividends are paid on a fixed percentage, stocks come with an increased risk of losing your principal and stock dividends are never guaranteed and the dividend per share is not fixed. These added risks and uncertainties of investing in stocks explains why investors expect to earn a better return on investment on stocks than they do on bonds. In other words, more risk equates to a higher expected rate of return.
This difference between a low-risk expected rate of return (such as the T-Bill rate), and the higher expected rate of return that comes from increased risk is often referred to as the risk premium.
Risk premium can be thought of as the percentage that would need to be added to a risk-free return on investment in order to entice an investor into investing in the risky investment being offered. Once this percentage is added, the result is referred to as the required rate of return.
With that, let's use the Stock Price Calculator to calculate the maximum price you could pay for a given stock and still earn your required rate of return.
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Current dividend per share: Enter the current dividend per share.
Stock growth rate: Enter the calculated growth rate. Please enter as a percentage (for .10, enter 10%). If you don't know the growth rate percentage, you can easily calculate it using my Growth Rate Calculator (opens in a new window).
Required rate of return: Enter the required rate of return. This is often arrived at by adding a percentage for risk premium to the T-Bill rate. Note that the required rate of return must be greater than the stock growth rate in order for the dividend growth model to be used for common stock valuation.
Stock price: Based on your entries, this is the maximum price per share you could pay and still earn your required rate of return.
Common Stock Valuation: The process of determining the maximum price you should pay for various stocks based on your required rate of return -- using one of several stock valuation models. The stock price calculator uses the dividend growth model to calculate price.