Estimating Spread for Required Rate of Return and Dividend Growth

B

The dividend yield gives an estimate for the spread between the required rate of return and the expected growth of dividends.

The correct answer to the question is B. dividend yield.

Dividend yield is a financial ratio that indicates the annual return an investor can expect to receive from owning a particular stock in the form of dividends. It is calculated by dividing the annual dividend per share by the stock's current market price.

The dividend yield provides an estimate for the spread between the required rate of return and the expected growth of dividends for a stock. It serves as an important metric for investors to assess the income-generating potential of an investment.

When an investor purchases a stock, they expect to receive both capital appreciation (increase in the stock's price) and regular income in the form of dividends. The required rate of return represents the minimum rate of return that an investor demands for taking on the investment risk. It typically includes the risk-free rate of return (such as the yield on government bonds) and a risk premium that compensates the investor for the additional risk associated with investing in stocks.

The expected growth of dividends refers to the anticipated rate at which the company's dividends are expected to increase over time. Companies with a history of consistent dividend growth or with promising prospects for future growth are often preferred by investors.

By comparing the dividend yield of a stock to the required rate of return, investors can assess whether the stock is likely to meet their investment objectives. If the dividend yield is higher than the required rate of return, it suggests that the stock may provide a satisfactory return. On the other hand, if the dividend yield is lower than the required rate of return, it indicates that the stock may not meet the investor's return expectations.

In summary, the dividend yield helps investors estimate the spread between the required rate of return and the expected growth of dividends, providing insights into the income potential of a stock investment.