I will preface this to say that yes of course I researched my face off for hours. And while the equation itself is explained (give me numbers and I can do it) all over the internet, the WHY of what is included is not clicking.
WHY on the bottom part of the equation am I subtracting the growth rate from the expected rate of return? The words “that is the effective discounting factor” mean nothing to me. I understand the “time value of money” concept (and suspect it has something to do with this); I do not understand how these two *particular* factors are the ones you need (to be divided by dividend price of course) to help determine the stock’s appropriate pricing.
What do those two amounts have to do with anything? Please help!
Edit: By explaining simply, I mean very very simply, like the link below, in an analogy, not using any financial terms. I am not a finance student.
https://www.reddit.com/r/explainlikeimfive/comments/kji6n/eli5_compound_interest/?utm_source=share&utm_medium=ios_app&utm_name=iossmf
In: 2
Two things aren’t being spelled out here. The value of a perpetuity (pays 1 periodically forever) is 1/i, the discount interest rate. So, the model values a stock price as if it were a perpetuity. The remaining question is What is the appropriate discount rate. The model claims that it is cost of capital less the expected growth rate of the company and by implication the dividend. Subtracting the dividend growth rate is a shortcut to discounting a series of payments growing at that rate
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