The Gordon-Shapiro Dividend Growth Formula and Inflation

The valuation model which discounts expected dividends is widely accepted in the finance literature. Beyond some point a constant growth rate in expected dividends is assumed. The accepted specification of this growth rate involves a constant retention rate for earnings, and is valid under no inflation. This paper derives the corresponding nominal formula under inflation using a retention rate defined in terms of inflation accounted earnings, and shows that its real counterpart is the accepted formula. It is also shown under inflation that the nominal formula using a retention rate defined in terms of historic cost earnings is considerably more complicated, and that a major error in share valuation results from mistakenly assuming the accepted formula to be valid in nominal terms with a retention rate defined in terms of inflation accounted earnings