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What is supernormal growth of a stock?
In a supernormal growth phase, the stock price increases at a rapid pace. The period in which such anomaly occurs lasts beyond a year. After the supernormal growth, the share shows general properties and grows at a normal rate. Super annual growth is a common phenomenon, provided there is demand for the product produced by the company in the market.
Dividend Discount Model: No Dividend Payments Growth
Preferred shares usually pay the stockholders a fixed amount in certain periods. Finding the next present value will give the implied value of the stock.
For example, if the company has to pay INR 1.50 in the next period and the required rate of return is 10%, the expected dividend value will be 1.50/0.10 = INR 15
The following formula is used to determine the rate −
$$\mathrm{𝑉 =\frac{𝐷_{𝑛}}{𝑘}}$$
Where,
- V = Value
- 𝐷𝑛 = Dividend in the next period
- k = Required rate of return
Constant Growth Model: Gordon Growth Model
Constant growth is suitable for larger, stable dividend paying organizations. It needs to look at the history of dividends payments and consider other factors, such as looking at the economy and the company’s retained earning’s policy.
The formula used to find growth in the Gordon Growth model is,
$$\mathrm{𝑉 =\frac{𝐷_{1}}{𝑘 − 𝑔}}$$
where g is the dividend payment rate.
Dividend Discount Model with Supernormal Growth
A dividend payment can be considered in two stages – first in "supernormal mode" and then in "normal mode".
Supernormal mode − This is a simple model where all the higher dividends of the next period are discounted back to the current period. This considers the supernormal growth rate. After this, the leftover consists of the value of dividends that will grow at a normal rate.
Normal mode − By working with the last period of higher growth, the calculation of the price of the remaining dividend is derived. The following formula is used in doing so −
$$\mathrm{𝑉 =\frac{𝐷_{1}}{𝑘 − 𝑔}}$$
However,𝐷1 in this case would be the dividend of the next year. 𝐷1 in this case will be considered to stay at a normal or constant rate.
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