CFA Practice Question
The P/BV ratio is negatively related to ______.
II. return on equity
III. required rate of return
IV. earnings growth rate
I. dividend payout ratio
II. return on equity
III. required rate of return
IV. earnings growth rate
A. I and III
B. II and IV
C. III only
Explanation: P/BV = (ROE - g) / (r - g). Empirical studies have also proved a strong positive relationship between the company's long-term growth and its P/B multiple but the relationship is not indicated by the equation.
User Contributed Comments 8
| User | Comment |
|---|---|
| turtle | the higher dividend payout ratio the lower g; the lower g the lower P/B P/B = 1+(ROE-r)/(r-g) so dividend payout is negatively correlated with P/B. |
| art1997 | P/B =(ROE-g)/(r-g) or P/B =ROE(1-b)/(r-g) => P/B and (1-b) ( dividend pay out ratio) are positively correlated at least from first point of view. Of course (r-g) also have connection to dividend pay out ratio... But think this way: if dividend big, book value get smaller and P/D get bigger... |
| danlan2 | We suppose ROE>=r and r>=g in order to get what turtle said |
| gradyb | Wait, turtle: ROE = growth/(1-payout ratio). So, if dividend payout ratio increases, ROE increases and therefore P/B increases. No clear relationship exists between P/B and payout ratio. |
| tim2 | I agree with gradyb - if a company makes a given profit, how the decision of wether to pay it out as dividends or retaina it affects the stock price is unclear - it may depend on the tax preference of the investors. |
| Hishy | P/B = (ROE - g)/(r - g) = 1+ (ROE-r)/(r-g) g = ROE*b So would b negatively affect P/B? |
| Hishy | Just did a rough example. Say ROE = 10% r = 11% b = 0.5 Therefore P/B = 0.833333 But if you increase b to 0.6, then P/B = 0.8. So if g = ROE*b, then b and P/B are inversely related. |
| somk | Hishy, u exactly proved the opposite. b is the retention ration, not payout ratio. the question asks about (1-b), not b. these sets of questions r too stupid if they just relate to payout ratio. try examples where ROE is greater than r, and examples where it's less and see for yoursleves. |