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When dividends are assumed to grow at a constant rate, the variables are: is the current stock price. is the constant growth rate in perpetuity expected for the dividends. is the constant cost of equity capital for that company.
Earnings growth rate is a key value that is needed when the Discounted cash flow model, or the Gordon's model is used for stock valuation. The present value is given by: = = (+ +). where P = the present value, k = discount rate, D = current dividend and is the revenue growth rate for period i.
The model states that: [] = + + + (/) [1]Where [] are the expected returns is the dividend in next period (period 1 assuming current t=0); is the current price (price at time 0) is the expected inflation rate
However, investors seeking capital growth may prefer a lower payout ratio because capital gains are taxed at a lower rate. High growth firms in early life generally have low or zero payout ratios. As they mature, they tend to return more of the earnings back to investors. The dividend payout ratio is calculated as DPS/EPS.
Two critical metrics help identify winning dividend growth stocks: the payout ratio and the dividend growth rate. A sustainable payout ratio (ideally below 75%) helps ensure the company can ...
However a company may elect to retain a portion of its earnings to produce incremental earnings and/or dividend growth. If the value of both dividends and retained earnings are considered, and the return on equity is equal to the firm's discount rate, the company could be valued by the same function (refer to relationship I):
With a modest 0.92% yield but an impressive 27.2% three-year dividend growth rate and a conservative 35.2% payout ratio, ... and proven track records of above-average dividend growth.
k = Discount Rate. g = Growth Rate. T 0 is the value of future cash flows; here dividends. When the valuation is based on free cash flow to firm then the formula becomes [+ ()], where the discount rate is correspondingly the weighted average cost of capital.