H-Model for Valuing Growth
- The H-Model is a modification of the Two Stage DDM. Unlike other two-stage models where the growth rate is assumed to be a constant, the H-Model assumes that the growth starts at a higher rate, and then gradually declines till it becomes normal stable growth rate.
- "H" represents half-life of the high growth period.
V0 = ((Div0 × (1+gmature)/(rce - gmature)) + ((Div0 × H × (ghigh - gmature)/(rce - gmature))
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H = one half of the growth period
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gmature = company’s growth rate in its mature phase
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ghigh = company’s growth rate in its high growth phase
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This model works well for companies that have an initial high growth rate but the growth is expected to decline as the firm becomes bigger, loses its advantage, or other factors.
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A flaw in the H-Model is that in order for it to work, the company in question must keep a constant payout ratio through all periods and this is a bit unrealistic.