We have P0/E1 = DR / (k-g) with DR being the dividend payout ratio. My favourite Secret Sauce says on p138 the P/E ratio “increases with D1 / E1, the dividend payout ratio.” and here again, I disagree. The reason is that g, the growth rate is also related to the DR: g = ROE * (1 - DR) so, P/E = DR / [k - ROE * (1 - DR)] You can easily study P/E as a function of DR and see that this function is not always increasing. Let’s take an example: ROE = 20% k = 10% Case 1: DR = 70% => P/E = 0.70 / (10% - 20% * 0.30) = 17.5 Case 2: DR = 80% => P/E = 0.80 / (10% - 20% * 0.20) = 13.3 In this example, the dividend payout ratio increases but the P/E ratio DECREASES. This is just an example to prove that the affirmative sentence from the Secret Sauce is WRONG. It does NOT prove that the P/E ratio decrease when the DR increases in ALL cases. In fact, the relation between the P/E ratio and the dividend payout ratio is more complex: - if k > ROE, then P/E increases when the dividend payout increases; - if ROE > k (and assuming k-g >0), then P/E DECREASES when the dividend payout increases. I would like this point to be corrected in the Secret Sauce. I guess the same error is the study notes, although I haven’t checked recently. It may be that the official reading is erroneous on this particular point but again, that is not a reason for the CFA candidates to learn something which is fondamentaly wrong. Marc
I recommend you stop using study materials and write your own. Perhaps you also ought to set up a rival qualification. Perhaps the Chartered Utter Nonsense Talker. Now all we need is a snappy acronym…
lol!!! You made my day chrismaths, it’s really slow today…
Damn i studied off of Secret sauce : (
Guys, Again, study materials are great! No doubt! There are just a few corrections to add. I would like Schweser to include them in the Secret Sauce Level 1 2008. That is all. I’m working for you, not against you. Where is the problem? Regards, Marc
You are talking bollocks. That’s the problem.
chrismaths, If this is bollocks then finance may not be for you. Marc
HAHAHAHA… Yes, this is very much bullocks, and I believe finance is for him. We’re just tire of you nitpicking secret sauce quotes. Like someone else said, get your CFA, then nitpick, or at least read the broader materials first. I honestly think alot of your posts come from lack of understanding of the underlying concepts. And statements like “finance may not be for you”, and other incorrect observations sound very uppity for someone who I am assuming by their abrasive attitude is still early in their career.
To sum up what every one else has been saying thus far, Secret sauce is a “quick review” tool. Not a substitute for material reading, understanding. In that context, it does a very good job. Some of the statements there may be out of the entire contextual flow of the material, it is a KEY note to “hold in memory” most of the time. That is the entire purpose of secret sauce, and IT DEFINITELY IS NOT A SUBSTITUTE FOR READING AND UNDERSTANDING THE BIGGER MATERIAL AND PICTURE. CP
Sigh… Marc - I don’t have secret sauce, but I do have a charter. I actually think this one is an important point, although I’m skeptical that Secret Sauce said that and I’m really skeptical that the readings said that. It’s really clear that you can’t uniformly increase your P/E by upping your dividend. The problem here is that you are being a d*&k about your aggressive posts (particularly to chrismaths who is not a guy I would trifle with). Look at the e-mail and see what you think - first off, your beef is not with anyone here; it’s with Schweser. Next, you should try writing something quickly and getting it error-free. Impossible. Tone it down and you will get lots farther.
I dont think the study material said INC in payout = INC in P/E. It is quite obvious that INC in payout would leave to smaller g, which leads to bigger denominator.
Agreed that tone is the main issue. Challenges to the curriculum and study materials are welcomed, but unless we’re cautious with our phrasing, it’s easy to descend into counterproductive arguments. You’re correct, and we actually had a good discussion on the payout ratio’s impact on P/E recently in a thread started by lola (see link below). http://www.analystforum.com/phorums/read.php?11,635886,635886#msg-635886 I think the following is a fair summary of CFAI’s approach to teaching intrinsic P/E: LEVEL I: The candidate is introduced to the dividend discount model (DDM) and shown how to adjust its constant-growth version into an equation for justified P/E: Constant-Growth DDM: P0 = D1 / (k - g) So now the candidate can determine either justified trailing- or leading P/E, depending on whether both sides of the equation are divided by E0 (current year’s earnings) or E1 (next year’s forecast earnings) Justified Leading P/E = P0/E1 = (D1/E1)/(k-g) = (1-b)/(k-g) * where “b” is the earnings retention ratio Justified Trailing P/E = P0/E0 = (D1/E0)/(k-g) = (1-b)(1+g) / (k-g) My understanding is that the relationship between ROE and k might be mentioned in the LI curriculum, but it’s not explicitly addressed until LII, when the candidate learns to break intrinsic P/E into its component parts as follows: LEVEL II Intrinsic P/E = Tangible P/E + Franchise P/E Tangible P/E = 1/k Franchise P/E = Franchise Factor * Growth Factor Franchise Factor = (1/k) - (1/ROE) Growth Factor = g / (k-g) So your observation is addressed in the calculation of the Franchise Factor. CFAI provides a good example which I reprinted in lola’s thread (link above)
ancientmtk, I’m not sure it is obvious: the denominator increases and so is the numerator. So which increases more? And in fact, it depends whether k>ROE or not… joeydvivre, I don’t have the charter but I have a number of other degrees, most more technical and I have SS Level 1 2007. Anyone can confirm my post. As for the reading, I can’t say. I keep repeating that Schweser is really great, and the SS is the part I like most. I have nothing against Schweser. Agree with you: impossible to write quickly such a document without a few errors. But then, let’s help Schweser correct them, no? chrismaths, sorry for my aggressive post. blackswan, I think a lot of my posts come a wish to understand the concepts. How many people have read in the SS that an INC in the dividend INC the P/E without noticing an error? In fact, when I read something, I’m always try to put all pieces together and sometimes they don’t fit. Regards, Marc
Obviously, you know the content of your post is right. If your ROE is greater than your capitalization factor paying out dividends is stupid and whatever the vice versa of that is is also true. I’m pretty sure most people at Schweser know that.
hiredguns1, Thanks for the link. It shows the question is not so trivial: I noticed a few L2 candidates haven’t fully understood the concept. Also discovered that the E/P concept is further analysed in L2. So finally I’m somewhat proud as an L1 candidate to have discovered an error that wasn’t that obvious and that most SS readers haven’t seen. joeydvivre, Then, I’m glad that this point is going to be corrected for the 2008 candidates. Regards, Marc
mhannebert, thanks for the comment. As joey points out, I prefer blamanche! Just a quick point - I think what this point hinges on is “all other things equal”. If you take that to mean ROE1=ROE2, then you’re bang on. But it’s easy to “overthink” these things - I think what the curriculum/schweser is attempting to say is that all other things *in the equation* being equal - so holding k and g constant. It’s *not* trying to say that upping your payout ratio will always up your p/e. 'Cos we both know trivially that that’s bollocks. So given 2 companies with the same growth rate, the same required return and the same earnings, the one with the higher payout ratio will have the higher P/E. Because given (retention rate) RR1ROE2. So no wonder company 1 has a higher p/e!
I like the rigor in your analysis. It just shows the importance of challenging and verifying the information we read (active studying) versus glossing over some words and diagrams and accepting them at face value (passive studying).
chrismaths Wrote: ------------------------------------------------------- > mhannebert, thanks for the comment. As joey points > out, I prefer blamanche! > > Just a quick point - I think what this point > hinges on is “all other things equal”. > > If you take that to mean ROE1=ROE2, then you’re > bang on. But it’s easy to “overthink” these things > - I think what the curriculum/schweser is > attempting to say is that all other things *in the > equation* being equal - so holding k and g > constant. It’s *not* trying to say that upping > your payout ratio will always up your p/e. 'Cos we > both know trivially that that’s bollocks. > > So given 2 companies with the same growth rate, > the same required return and the same earnings, > the one with the higher payout ratio will have the > higher P/E. > > Because given (retention rate) RR1ROE2. So no > wonder company 1 has a higher p/e! I’m sure Schweser would go with that, but it really is BS. Growth rate and retention ratio are so completely linked that those “holding them equal” explanations don’t really work. As you say though, if two companies have the same growth and risk but one pays out more cash, I’m taking the cash.
gdiddy, joeydvivre, Thanks! Marc
Go mhannebert! Don’t let those arrogant posters slow you down. Many people on this board approach the material for passing only without really understanding or questionning what is being thrown at them. These guys will never make it big in the real world… phonies are phonies and true professionals can easily see through them. J