Do Dividend-Paying Stocks Have Lower Cost of Equity Implied by CAPM?
I understand that Cost of Equity = risk-free rate + levered beta × market risk premium, so stocks' CoE calculation differ in levered beta; levered beta is calculated by taking the mean unlevered beta from public comps and re-levering it based on the company's financial structure.
So if there're two companies that are identical except for dividend policies - A pays dividends but B does not. (I think) A is supposed to have a lower levered beta, but this will implies that A will also have a lower CoE given by CAPM? This doesn't make sense to me.
If strictly following the calculation, the only way for A to have a lower levered beta is to have lower median unlevered beta from comps. I am not sure about this either.
Hope some monkeys can help on this. Many thanks.
Hi Intern in IB-M&A, yes, I'm a bot, but I'm also good looking. Hopefully, these threads help you:
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I hope those threads give you a bit more insight.
Hey,
From a theoretical point of view - beta measures risk and a company that pays dividends is lower risk to any investor than one that does now, therefore the lower cost of equity.
From a mathematical perspective - beta can also be calculated by (E(rs)-rf) / (E(m)-rf). Now, the company not paying dividends should have a higher return than the one that does - (higher risk - higher reward). Therefore, making its beta higher and making the cost of equity higher.
In short think of it like this - i have both investments (A,B). Now, since they are identical i could put my money at A or at B (doesnt matter). Let's also say they are both expected to give me 5% return with a probability of 80%. However, one of them (namely: A) says that a portion of that money is 100% guaranteed (see: dividend) while the other one is to receive at 80%. Well, of course i would choose A. Therefore, B would have to have higher return to convince me as an investor to buy B - meaning higher cost of equity.
Hope that helped
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