Statement 2: When firms pay out profits as dividends at a higher rate, a firms intrinsic P/E value decreases. How is this correct? Intrinsic P/E = Payout ratio / (r - g).
refer to the answer, it explains very well consider the formula intrinsic P/E = tangible + franchise
I think the problem here is that you have two variables, Payout ratio, and growth - g. In this case payout ratio increases, and supposedly g decreases. How are you to know that g decreases to the point where intrinsic P/E declines? Bad question in my mind.
Well, this is a conceptual question and not a quantitative one. It makes sense if you think about it. The firm is paying out more dividends, meaning they aren’t reinvesting it into the firm, slowing down growth.
When I see “intrinsic P/E” I think of the formula. If they just used “P/E” that would’ve made it more conceptual.
look at it this way: g decreases. So (r-g) on the denominator INCREASES. So numerator and denominator both are less than 1 and numerator decreased, denominator increased. ratio as a whole will decline.
cpk123 Wrote: ------------------------------------------------------- > look at it this way: > > g decreases. So (r-g) on the denominator > INCREASES. So numerator and denominator both are > less than 1 and numerator decreased, denominator > increased. > > > ratio as a whole will decline. …but the numerator increases as well since the payout ratio increases.
just put numbers in to be really sure ROE=15% payout is 50% g=.5*15%=7.5% r=10% PE=20 if payout is 70% then g is 4.5% and PE is 12.72 you denominator increases by higher percentage than your numerator which is why PE goes down as pay out is increased. Or in simpler words as growth slows down market value will go down as market value reflects future earnings. So price is down and so is P/E.