Chartered Financial Analyst (CFA) Practice Exam Level 2

Which of the following statements is true regarding dividend payout ratios?

1. High Dividend Payout Ratio = High Growth

2. Low Dividend Payout Ratio = Lower Equity Valuation

3. High Dividend Payout Ratio = Lower Growth

4. Low Dividend Payout Ratio = Increased Equity Valuation

The correct answer is: High Dividend Payout Ratio = Lower Growth

The statement that a high dividend payout ratio equates to lower growth is aligned with the financial principles of how companies allocate their earnings. A high dividend payout ratio indicates that a larger portion of a company’s earnings is distributed to shareholders as dividends rather than being retained within the company for reinvestment. When a company pays out a significant portion of its earnings in dividends, it has less capital available to reinvest in growth opportunities such as research and development, new projects, or expansion initiatives. As a result, companies with higher dividend payout ratios may have limited resources to fuel growth, which can lead to a perception of lower growth potential in comparison to their counterparts that retain a larger share of their earnings. This understanding ties into the broader context of how dividend policies are formulated. Growth companies often maintain lower payout ratios because they prioritize reinvesting profits to capitalize on lucrative opportunities, while more mature companies might opt for higher payout ratios as their growth prospects stabilize. Consequently, this relationship suggests that companies with a high dividend payout ratio typically do not experience rapid growth, supporting the validity of the assertion.