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?

Question

Quizplus · Accepted Answer

According to the constant growth model, the stock price is determined by the dividend yield and the dividend growth rate. If one stock has a higher dividend yield, it means that it is paying a higher proportion of its earnings as dividends compared to the other stock. Therefore, to maintain equilibrium, the higher yielding stock must have a lower dividend growth rate. This is because a higher dividend payout leaves less money for the company to reinvest in its business and generate future earnings growth. The lower growth rate compensates for the higher current yield.

Two Constant Growth Stocks Are in Equilibrium, Have the Same