Which one influences growth more? Specifically the P/E. 1. Higher Dividend Payout Ratio 2. Higher Retain Earnings Thx!
Not sure how to answer this, the higher the Payout Ratio the lower the Retained Earnings and the lower the growth rate. A higher Retained Earnings implies a lower Payout Ratio and a higher growth rate. This also only for a specific year’s RE, RE is generally reported as cummulative.
Wouldn’t a company with higher retain earnings have higher growth compare to a company that pays most of their earnings to dividends?
yes, I believe that’s what i state above.
Only if ROE is higher than the required rate. If you keep retaining earnings, yet returning less than what the equity holders could do on their own, growth is weak.
Leading P/E states => Higher Div Payout = Higher P/E Sust. Growth Rate states => Higher Retention Rate = Higher Growth = Higher Growth of Company = Higher P/E Is the answer both? But they’re an inverse relationship…
I think the thing to remember is that everything is related, those two equations are not isolated from one another. Meaning if you’re dividend payout ratio increases it will effect your growth rate too, the two variables have to move together. So, take the leading P/E equation, if your payout ratio increases, i agree it increases the value of the numerator, but it also has to change the growth rate in the denominator, so it’s not given that it leads to higher P/E Dreary makes an excellent point as well.
Conceptually, I think of growth due to two factors: NI and Retained Earnings. When both are high the value of the company will be high. Hence the ROE spread would widen, assuming cost of equity for the firm is constant. Therefore growth should increase with the change of ROE. Value of the firm should increase. The company should be trading at a higher price multiple. Prior to studying the CFA, I knew leading P/E was simply today’s stock price dividend by previous 12 mth EPS. Now, I’m thrown the formula for justifying the leading P/E, it tells me the leading P/E increases as the Dividend Payout Ratio (DPR) increases. That contradicts my understanding of high RE increases firm value. Thanks for your comments guys.
“the leading P/E, it tells me the leading P/E increases as the Dividend Payout Ratio (DPR) increases.” - where are you getting this from? there’s two formulas you need here: g = ROE x b leading P/E = (1 - b) / (r - g) if b decreases (same as increasing the dividend payout ratio), then g changes as well, there’s an effect on the numerator and denominator of the leading P/E formula, so it’s not a given and a decrease in b will increase leading P/E
r0424 - I was wrong of leading P/E increasing w/ increasing DPR. I had to walk away from studying for a little bit and came back, plugged some numbers in Excel, and realized what I said didn’t hold true. Sometimes I just have to walk away from studying otherwise I’ll be confusing myself with simple things like this. So to answer all the above. 2. Higher RE = higher growth. Thx!