Share repurchases and Gordon Growth Model?

CFA Level II Equities
#1

Hello,

In the Official CFA Curriculum for Level 2, 2018, Reading 30, Practice Problems, there is questions number 49, which aks:

Which sector report best describes a situation in which the Gordon growth model could be used to value utility stocks?

  1. Report 1
  2. Report 2
  3. Report 3
  • Report 1: A resurgence in domestic manufacturing activity will generate long-term growth in earnings and dividends that exceeds the cost of equity.
  • Report 2: Share repurchases are expected to increase. The report expresses confidence in the forecasts regarding the magnitude and timing of these repurchases.
  • Report 3: The report forecasts earnings growth of 4.5%. The key growth drivers are increases in population and business creation associated with stable GDP growth of 2.75%.

B is correct because the Gordon growth model can accurately value companies that are repurchasing shares when the analyst can appropriately adjust the dividend growth rate for the impact of share repurchases.

(Institute 265)

Institute, CFA. 2018 CFA Program Level II Volume 4 Equity. CFA Institute, 07/2017. VitalBook file.

Why is it not Report 3?

#2

It’s not 3 because long-term growth of a company or industry cannot exceed the long-term growth rate of the economy.

#3

Oh, that makes sense!

QQ!

#4

I’m allowed to make sense only once a week.

You got lucky.

You’re quite welcome.