What is a practical disadvantage of the Gordon model for equity valuation?

The Gordon model, also known as the Gordon Growth Model or Dividend Discount Model, is a method used to determine the value of a company's equity based on the present value of expected future dividends. The model assumes that dividends will grow at a constant rate indefinitely. While this model is useful in many scenarios, a practical disadvantage arises from the requirement to project dividends "forever" into the future.

This assumption of perpetual dividend growth can be problematic for several reasons. First, accurately predicting dividends for an indefinite period poses significant challenges, as companies may not consistently increase their dividends due to changes in earnings, economic conditions, or company-specific factors. Additionally, many companies do not pay dividends or have erratic dividend policies, making it difficult to apply this model effectively to a wide range of firms.

Other factors like market conditions and the specific applicability of the model to various company sizes do not directly address the core challenge related to long-term projections. Consequently, while the Gordon model simplifies the valuation of stable dividend-paying companies, the unrealistic expectation of constant growth into perpetuity can hinder its practical application.