Two constant growth stocks are in equilibrium, have the same price, and have the same required rate of return.Which of the following statements is CORRECT?
A) If one stock has a higher dividend yield, it must also have a lower dividend growth rate.
B) If one stock has a higher dividend yield, it must also have a higher dividend growth rate.
C) The two stocks must have the same dividend growth rate.
D) The two stocks must have the same dividend yield.
E) The two stocks must have the same dividend per share.

Question

Quizplus · Accepted Answer

If two constant growth stocks have the same required rate of return and the same price, then they must have the same dividend growth rate as well. Therefore, if one stock has a higher dividend yield (dividend per share divided by price), it must be because its dividend growth rate is lower. This is because the dividend yield is equal to the dividend payout ratio (dividends per share divided by earnings per share) multiplied by the dividend growth rate, divided by the required rate of return minus the dividend growth rate. If the required rate of return and price are the same for both stocks, then the only way for one stock to have a higher dividend yield is for its dividend growth rate to be lower.

Two Constant Growth Stocks Are in Equilibrium, Have the Same