Marlene Gooseberry, an institutional money manager with Middle Road Brokerage, has been examining a stock market series and has determined the following information:
The dividend payout ratio has been estimated at: 31% The required rate of return is 16% per year
The anticipated future growth rate of dividends is 13.75% per year The anticipated future growth rate of earnings is 14.25% per year The corporate tax rate is 35%
What is the earnings multiplier for this stock market series? Choose the best answer.
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A. B. C. D. E. F.C
Estimating the earnings multiplier for a stock market series requires the estimation of each of the following components:
The dividend payout ratio.
The required rate of return on common stock in the country/region/industry/sector being analyzed.
The expected growth rate of dividends for the stocks in the country/region/industry/sector being analyzed.
Once values for each of these components have been determined, they are imputed into the following formula:
P/E = [D/E / (k - g)]
Where: P/E = the earnings multiplier, or Price-to-Earnings ratio, D/E = the dividend payout ratio at t1, k = the required rate of return, and g = the anticipated growth rate of dividends.
In this example, all of the necessary information has been provided, and the calculation of the earnings multiplier is shown as follows:
P/E = [0.31 / 0.16 - 0.1375] = 13.78
Notice that it was the anticipated growth rate of dividends, not the anticipated growth rate of earnings, which was used in determining the earnings multiplier.
Additionally, note that the tax rate was notexplicitly factored in to the equation, as the earnings figure used in the dividend payout ratio is already an after-tax figure.