Factors Affecting Market P/E Ratio

D

P/E = (dividend payout ratio) / (k - g)

k = real rate + inflation = risk premium

g = (ROE) (retention rate)

a. ROE up, g up, P/E up; Payout up, P/E up;

c. g up, k-g down, P/E up; k up, P/E down

To determine which factor would reduce the market P/E (Price-to-Earnings) ratio, let's analyze each answer option:

A. The market ROE (Return on Equity) is expected to increase: The market P/E ratio is calculated by dividing the market price of a stock by its earnings per share (EPS). A higher ROE indicates that the company is generating more profits from its shareholders' equity. If the market ROE is expected to increase, it implies that companies are becoming more profitable. This would likely lead to an increase in earnings, which in turn could result in a higher market P/E ratio rather than reducing it. Therefore, option A is unlikely to be the correct answer.

B. The dividend payout ratio increases: The dividend payout ratio is the proportion of earnings that a company pays out as dividends to its shareholders. If the dividend payout ratio increases, it means that a larger portion of earnings is being distributed as dividends. This could result in a lower retained earnings amount, which might lead to a decrease in the market P/E ratio. Investors might perceive this as a lower growth potential for the company, hence reducing the P/E ratio. Therefore, option B is a potential answer.

C. The dividend growth rate increases: The dividend growth rate measures the rate at which a company's dividends are expected to increase over time. If the dividend growth rate increases, it suggests that the company is expected to increase its dividend payments at a faster pace. This could be an indication of strong financial performance and growth prospects, which may result in a higher market P/E ratio rather than reducing it. Therefore, option C is unlikely to be the correct answer.

D. The required rate of return increases: The required rate of return reflects the minimum return an investor expects for taking on the risk of investing in a particular stock. If the required rate of return increases, it implies that investors are demanding higher returns to compensate for the increased risk. This can lead to a decrease in stock prices and, consequently, a lower market P/E ratio. Therefore, option D is a potential answer.

Considering the explanations provided, options B and D are the potential answers that could reduce the market P/E ratio. To determine the correct answer, additional context or information from the question or reading material may be required.