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I need to compute the expected growth rate of a stock given the data: financial leverage 2.0 return on assets 16% dividend payout ratio 60%

I don't know how to compute it nor where to start, could you please help me?

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  • $\begingroup$ Think about the firm paying 60% of its profit as dividend, it means that it's keeping 40% in equity... $\endgroup$ – Louis. B Nov 19 '15 at 2:02
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Lets start with the Return on Equity (RoE) formula as you already have some of the information given:

RoE = (Net Income/Sales)x(Sales/ Total Assets)x(Total Assets/Shareholders' equity)

Now the first two terms describe the Return on Assets (take out the Sales from the denominator of the first fraction and from the numerator of the second fraction):

RoA = Net Income/Total Assets and we know RoA = 0.16

Your financial leverage ratio is Total Assets/Shareholders' equity = 2.0. Your retention rate is b= 1-payout ratio = 1-0.60 =0.40

The last equation we need is the one for the growth rate: g = b x ROE =0.40 x 2.0 x 0.16 =0.128 or 12.8%

I hope it helps, if you can get access to CFA material (paid or publicly available) go through it as it explains it all well (any and all mistakes here are solely mine of course :-) ...)

Note also that some sources talk about Average Total Assets and Average shareholders equity etc which is the complete and correct way of calculations as they can and do change in the course of a financial year. I kept above formulas simple but one still gets the gist I hope...

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