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Unformatted text preview: mic consequences. From an accounting standpoint, this action will reduce the book
value of equity in the firm. From an economic standpoint, the firm is not only not
reinvesting back into the business but is reducing its asset base, thus reducing its capacity to
grow in the future.
While avoiding firms that pay out more than what they are earning as dividends may
be an obvious strategy, you could impose tighter constraints. F or instance, some
conservative investors and financial advisors suggest that you avoid firms that pay out more
than a certain percent of their earnings – two thirds (or a payout ratio of 67%) is a
commonly used rule of thumb. While these constraints are usually arbitrary, they reflect the
fact that earnings are volatile and that dividends in firms that pay out more than the cut-off
payout ratio are at risk.
Revisit the sample of the 100 companies with the highest dividend yields (from
Table 2.3) and compare annual dividends to trailing earnings - earnings in the most recent
four quarters. Figure 2.8 summarizes the findings...
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- Spring '11