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Unformatted text preview: ends. This is also true, albeit to a lesser
degree for Telesp Cellular.
As a firm increases the dividends it pays to stockholders, it is reinvesting less of its
earnings back into its business. In the long term, this has to translate into lower growth in
earnings per share.8 In fact, the long term sustainable growth rate in earnings per share for a
firm can be written as a function of its payout ratio and the quality of its investments
(measured by its return on equity):
Expected Long-term Growth rate in earnings per share = (1- Payout ratio) (Return on
To illustrate, a firm that pays out 40% of its earnings as dividends and earns a 20% return
on equity can expect to see its earnings per share grow 12% a year in the long term.
Expected growth rate in earnings per share = (1 - .40) (.20) = .12 or 12%
Investors who invest in companies that pay high dividends have to accept a trade off. These
firms will generally have much lower expected growth rates in earnings.
Consider again the sample of high divid...
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This note was uploaded on 01/17/2012 for the course ECON 101 taught by Professor Econnorm during the Spring '11 term at Art Institutes Intl. Minnesota.
- Spring '11