H-model

A dividend model in which an above-normal growth rate declines in a straight line to a long-run rate, rather than dropping abruptly. It gives an approximate value in a single expression.

Where you will meet it

H-model appears in 4 learning outcomes on the CFA syllabus. A few of them:

• Use a dividend discount model with several growth stages
  CFA Level I · Equity Investments

  “A two-stage model with an abrupt drop in growth is a simplification; an H-model fading growth linearly is often the more plausible shape.”

• Back out a required return from any DDM, including the H-model and the Gordon growth model
  CFA Level II · Equities

  “With the H-model, in which growth starts at gS and declines linearly to the long-run rate gL over 2H years, the implied return is r = (D0 ÷ P0) × [(1 + gL) + H × (gS − gL)] + gL.”

• Explain what spreadsheet modelling, the H-model, the two-stage DDM and the three-stage DDM assume, and argue for choosing one to value a firm's shares
  CFA Level II · Equities

  “The H-model assumes growth falls in a straight line from a high rate to the stable rate, which fits an advantage that erodes gradually; it is an approximation that works best when the period is short or the gap between rates is small.”

• Value common shares with the H-model, the two-stage DDM and the three-stage DDM, and explain the results
  CFA Level II · Equities

  “The H-model captures a linear decline in growth in closed form: V0 = D0 × (1 + gL) ÷ (r − gL) + D0 × H × (gS − gL) ÷ (r − gL), where H is half the length of the decline in years.”

Practise it

• Today's practice question One question, with every wrong option explained.
• Free Level I diagnostic test Twelve questions that show which topics to start with.
• Free finance calculators Check your arithmetic on the exam's core formulas.

All terms beginning with H · Glossary