so as RR increases, growth increases, which decreases the (k-g) component, thus increasing P/E but when the RR increases, the D/E, which is our numerator, goes down, which should decrease P/E has anyone noticed that? isn’t this a contradiction?? how do you resolve it?
Be careful how you use RR here…RR can be retention rate or required return, two completely different things.
Also rest and relaxation, railroads, Ronald Reagan, and the noise that Somali pirates make while chasing cruise ships.
ah yes the pirates…i knew that. rest and relaxation–my plan for the next day and a half.
I think that the change in g will have a greater affect.
ok this is interesting [and btw RR here = retention ration] it does affect both the numerator and the denominator, but apparently if ROE>k, then an increase in RR increases P/E. but if your k>ROE, then an increase in your RR would decrease P/E basically if you can earn more with the money than it costs you to get it, we want you to keep it. if not, we want you to distribute it as dividends. someone smart tell me if that makes sense
hi well, why should it be like this? if P = D1/(k-g) and D1 = E*(1+g)*(1-RR) and g = ROE*RR then P/E = (D1/E)/(k-g) = (1+g)*(1-RR)/(k-g) = (1+RR*ROE)*(1-RR)/(k-RR*ROE) if, for example k = ROE, then this simplifies to (1+RR*ROE)/ROE hmmm… >basically if you can earn more with the money than it costs you to get it, we want you to >keep it. if not, we want you to distribute it as dividends. that sounds reasonable!
p/e = (d/e) / (k-g) is the numerator d1/e0 or d1/e1
here is the trick i saw…which i think is the same as ludwig.wittgenstein just without formulas if ROE is above k that means investors would rather have their money invested in the company so if retention ration increases P/E will go up as price would increase. If ROE is less then K then as investor you want your money so you can invest somewhere else, so higher retention ration will decrease P/E cuz price will decrease.