Your Money: Know the five characteristics of a stable firm

by Jeremy
The growth rate for AM is lower compared to the long-run expected growth rate for India.

Investors can be categorized into risk-taking and risk-avoiding groups. Risk-avoiding investors aim to invest in stocks that do not exhibit huge fluctuations in fundamentals. The firms which report stable financials are called regular firms. Let us look at the characteristics of a traditional firm.

Your Money: Know the five characteristics of a stable firm

Higher dividend payout or lower retention rate

Stable firms are those which have a lower need for reinvestment in working capital and capital expenditure. A lower reinvestment need allows them to return a higher portion of the cash flows as dividends to its shareholders. For instance, Abhishek Mahimn Ltd (AM) has a dividend payout ratio (DPR) of 70% in its recent financial year. This indicates that its reinvestment (retention) rate is 30%. This firm is stable as it is reinvesting less and returning more to its shareholders.

No excess returns

Stable firms may not generate excess returns. They report a return on equity which is just enough to cover their cost of equity. This means that these firms earn an industry average profit margin. They have industry average asset turn and equity multiplier. For instance, the ROE of AM is 12% which is equal to its cost of equity of 12 %. Further, the firm’s Dupont components are similar to that of an average firm in its sector.

Lower growth rate

The actual growth rate in earnings for equity shareholders could be computed as the product of a firm’s return on equity and its retention rate. The retention rate is calculated by subtracting the dividend payout ratio (DPR) from 1. The actual growth rate for AM is 3.60% (= product of ROE of 12% and retention rate of 30%). The growth rate for AM is lower compared to the long-run expected growth rate for India.

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