Chartered Financial Analyst (CFA) Practice Exam Level 2

During which phase is a company's earnings growth high but dividend payout low?

1. Mature Phase

2. Initial Growth Phase

3. Declining Phase

4. Transition Phase

The correct answer is: Initial Growth Phase

The initial growth phase is characterized by high earnings growth and a low dividend payout. During this stage, a company typically experiences rapid expansion as it capitalizes on new market opportunities or innovations. This growth is fueled by reinvesting profits back into the business to finance development, research, and operational scaling rather than distributing it to shareholders as dividends. Companies in this phase prioritize reinvestment over returning cash to shareholders because they need capital to enhance production capacity, expand their market reach, or innovate further. This approach allows them to sustain their growth trajectory, laying the foundation for stronger performance in later phases. In contrast, in different phases like the mature phase, the growth rate tends to stabilize, and companies often shift towards higher dividend payouts as they have less need for reinvestment. During the declining phase, earnings might decrease, affecting both growth and dividends. The transition phase can involve varied strategies, but it often includes adjustments from growth to maturity, where reinvestment rates begin to stabilize. Thus, the initial growth phase distinctly supports high earnings growth with low dividend payouts.