Gordon Growth — P = FCF/(r − g) and what it means

The single most important equation in this quest

Take the perpetuity from last lesson — P = C / r. Now suppose the cash flow doesn't stay flat — it grows a bit each year. Maybe the company's earnings grow at g percent per year, forever. Year 1 you get C; year 2 you get C × (1+g); year 3 you get C × (1+g)^2; and so on, growing at rate g indefinitely.

The math works out beautifully. The price of an infinite stream growing at rate g, discounted at rate r, becomes:

This is the Gordon Growth Model. Named after Myron Gordon, who formalized it in 1959. It's the most important valuation equation you'll meet in this entire quest. Lock it in. (One condition: r > g. If growth equals or exceeds the discount rate, the formula gives nonsense — you'd be claiming infinite value, which means the model has hit its limits.)

Same picture, longer denominator

Stop and stare at P = C / (r - g). It's still numerator–denominator play. Numerator: C. Denominator: r − g. Three drivers now:

1. C goes up — current cash flow rises (numerator up). Price up.
2. r goes down — interest rates fall (denominator down). Price up.
3. g goes up — growth expectations rise (denominator down because we're subtracting a bigger thing). Price up.

This is exactly Track 1 lesson 3 in concrete form. Three drivers. Three. Every market move you've ever seen is one of these three things or some combination. The thesis lesson promised this; here's the payoff.

Why this is the parent of essentially every stock-valuation equation

Real companies don't just produce one cash flow forever. They produce a stream of cash flows that vary year to year. But if you're willing to assume the cash flow grows at some long-run rate, Gordon Growth is the right model. And even when it isn't directly applicable, almost every fancier model is built on top of it:

• Dividend Discount Model (DDM): just Gordon Growth with dividends as the cash flow.
• DCF (Discounted Cash Flow): explicit forecasts for the first 5–10 years, then Gordon Growth for "everything after." That second piece is called the terminal value, and it's usually a Gordon-shaped equation.
• P/E ratio: rearrange Gordon and you get a relationship between price-to-earnings and growth rate. We'll see this in Track 6.

NVDA and Adobe — the cases promised in lesson 3

Now we have the math to actually see why NVDA can drop on a great quarter and Adobe can drop 30% on okay earnings.

NVDA on a beat: earnings come in great. C goes up — numerator up. But the market's expected g was so high that the actual growth, even though massive, came in a touch below expectation. So g dropped slightly in the market's view. Denominator (r − g) got slightly bigger. Result depends on how much: if (r − g) grew by more (in percentage terms) than C grew, then P falls. The market's reaction is exactly that math reading.

Adobe in 2024: the market began doubting the company's long-run growth. Maybe AI tools eat its core business. g in the market's view collapsed — possibly to near zero. Denominator (r − g) shot up because g shrank. C barely changed. Bigger denominator + same numerator = much smaller P. The 30% drop is what that re-pricing looks like in the wild.

This is what you've been building toward through the whole math reset of Track 1 and the TVM track. We'll go deeper in Track 6 (equity valuation), but the engine is here, in this one equation.

The takeaway

Gordon Growth — P = C / (r − g) — is the single equation worth burning into your head. Three drivers (C, r, g) and one rule (r must be greater than g). Almost every other valuation model is some elaboration of this. And every "why did the stock move?" question can be answered, at least in principle, by asking which of C, r, or g moved, and which way.

Next track (Risk & Return) returns us to volatility. Then markets, statements, and the equity track where Gordon Growth comes back in full force. From here on, the rest of the quest is mostly elaboration.