PEG ratio

If payout ratio remains constant, dividend growth and EPS growth will be equal. Example: Payout ratio 50%, EPS Growth rate 10%. Year 1. EPS = 1.00, Dividend = .50 Year 2. EPS = 1.10, Dividend = .55 Year 3. EPS = 1.21, Dividend = .605 Dividend has also grown 10% each year.

On the exam are we to assume that dividends and earnings grow at the same rate? You could argue that B or C is right depending on your view of this assumption. (The assumption may not be true if a firm is growing, but doesn’t pay dividends because its more beneficial to reinvest the earnings than pay dividends.) Am I over analyzing this? I vote - bad question.

kris10 Wrote: ------------------------------------------------------- > On the exam are we to assume that dividends and > earnings grow at the same rate? You could argue > that B or C is right depending on your view of > this assumption. (The assumption may not be true > if a firm is growing, but doesn’t pay dividends > because its more beneficial to reinvest the > earnings than pay dividends.) Am I over analyzing > this? > > I vote - bad question. But if it’s “zero expected dividend growth prospects”, then growth rate is 0. You can’t possibly divide by zero. How can option A be correct? That the expected dividend growth rate of zero will cancel out in the computation of the PEG ratio? You want to divide 20 or 30 or 40 by 0?

guys, just look in your books, even look on wikipedia; the G in peg ratio is for EPS growth rate, not dividend growth rate. Answer is C.

Option A isn’t right - at all. B/C are the only two possible right answers. I agree that any number divided by 0 is undefined. However, I’m not questioning that. What I’m questioning is the portion in the original question that states “the PEG ratio may be used to value firms with zero expected dividend growth prospects.” ----> Yes, because we use the earnings growth. Unless we assume that zero expected dividend growth mean zero earnings growth. Answer Choices (B & C only) B. No, because the PEG ratio is undefined for zero-growth companies. —> True, but the question didn’t ask about a firm with zero-growth. It asks about a firm with zero dividend growth. Again, depending on your view of the assumption that earnings & dividend growth are the same this could be true/false. C. Yes, because the computation of the PEG ratio does not use the rate of expected dividend growth. ---->True, but again, may be true/ false depending on your view of the assumption that earnings and dividends growth are the same. So, my question is, are we truly to assume, unless told otherwise, that earnings and dividend growth are the same?

magicskyfairy Wrote: ------------------------------------------------------- > guys, just look in your books, even look on > wikipedia; the G in peg ratio is for EPS growth > rate, not dividend growth rate. Answer is C. You know you might be right, dude. haha.

“zero expected dividend growth prospects” the entire point of the discussion lies around “dividend growth prospects”, not around “dividend growth” per se. And we all, I think agree - that “Dividend growth prospects” in order to be sustainable, can only happen when there is “earnings growth”, i.e. g > 0.

double post sry

to CP, I respectfully disagree, and I’ll site an example why: RIM had great Earnings for years and were growing like a tank of sea monkeys, but the prospects for getting a dividend from them were nil because they simply didn’t pay them; it was all reinvested. If k=0 and expected k is also equal to 0 (like in this question), without more information, you can’t also make the assumption that earnings growth is 0 too, that’s just not a reasonable assumption. I’m sticking to my guns with answer is C

your choice… as is always the case…

There are two types of questions pertaining to formulas: 1. Questions that help you understand what the formula is relating to, and 2. Questions that only test you on the mechanics of the inputs. we could all cite companies that have 0 div growth and some type of EPS growth. This question is not applicable in the real world b/c as we all know, divs are a function of management disctretion and an approved div policy. to assume the div growth rate is the same as EPS growth is assinine and would actually be, in the real world, a violation of standard V. A. Diligence and Reasonable Basis in Investment Analysis.

cpk123 Wrote: ------------------------------------------------------- > “zero expected dividend growth prospects” > > the entire point of the discussion lies around > “dividend growth prospects”, not around “dividend > growth” per se. > > And we all, I think agree - that “Dividend growth > prospects” in order to be sustainable, can only > happen when there is “earnings growth”, i.e. g > > 0. totally agree with you CP

to FinNinja… yeah, I agreeish. But to be fair to this question, I don’t think it’s making the implication that “dividend growth prospects” are the same as “earnings growth prospects”. That’s an assumption a lot of people on this forum made on their own, and that’s the type of thing that can burn you in a multiple choice test. While I do agree that earnings growth has to be good in order to facilitate good dividend growth, I don’t agree that earnings growth implies good dividend growth prospects because, as the text points out, firms will reinvest their earnings and not pay dividends when they have good investment prospects (see the Residual Income section in equity somewhere, I think session 12 somewhere). My issue with CP’s statement of: > And we all, I think agree - that “Dividend growth > prospects” in order to be sustainable, can only > happen when there is “earnings growth”, i.e. g > > 0. is that there seems to be (and maybe I’m interpreting wrongly) an assumption that dividend growth prospects depend solely on the ability to pay them, and that’s just not true. There has to be the desire to pay as well. If the company has crazy high earnings growth, but don’t have any intention to pay any dividends, your prospects of receiving some, as an investor, are nil.

If dividends growth does NOT match Earnings growth, then we anyways CANNOT use ANY kind of Dividend Discount Model for valuations. So, given that we are using DDM for evaluation, we must assume that dividend growth will closely match Earnings growth. And with this assumption, choice C is incorrect. I would have gone for choice B as most appropriate.

Only for the CFA does a simple question turn into a full blown 2 pages of disagreements. God this stuff can be horrible sometimes!

responding to rus1bus: >So, given that we are using DDM for evaluation, we must assume that dividend growth >will closely match Earnings growth. Disagree completely; as I mentioned several times, the PEG ratio is not a DDM since the g refers to earnings growth, not dividend growth. It’s overly presumptuous to make assumptions about earnings growth based on the fact that there are ‘zero prospects for dividends’. Several companies with great consistent earnings growth don’t pay dividends, and their PEG ratios would be meaningful.

Indeed. CFA detaches from reality quite frequently… more important to “learn to the test” at this point unfortunately (for me at least).

You can’t reconcile what occurs in the real world and what we have to know for the CFA exam. Unless there’s an errata out there, the answer is B. End of story.

I’m not reconciling $hit. You want proof? Fine. FU enterprises is a publicly traded company that manufactures terrible conclusions on the analyst forums. Their shares trade for $15 and they had an EPS of $3 last year. The company’s sustainable earnings growth rate is estimated to be 5% annually. It has never paid a dividend, and has no plans to either. To be perfectly clear, the prospects of receiving a dividend from this company in the foreseeable future are non existent. Which of the following is the company’s PEG ratio? a) undefined because dividend growth is 0 b) 1.0 c) 0.952 Answer is C => (P/E)/g => (15/3.15)/5 => .952 There you go; a perfectly meaningful peg ratio for a company that will not pay dividends. As for the question posted to this thread, Answer is also C. Now it’s end of story

b - ridiculous question…