Determinant 1: The Expected Growth Rate

In order to unuderstand Growth Rate one must understand how Compound Interest works:

If Jean-Paul invests a Principal, P, of $1.00 at a growth rate, r, of 5%

Present Dividend = $1.00 Dividend in n years = P(1 + r)^n

Thus we can draw following Table:

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Growth Rate    Present Dividend   Dividend in 5 yrs  Dividend in 10 yrs    Dividend in 25 yrs
  
        5 %	          $1.00	              $1.28	          $1.68	                $3.39
        10%	          $1.00	              $2.01	          $4.05	               $32.92
        25%	          $1.00	              $3.05	          $9.31	              $264.70

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Malkiel notes that many newly established coporations perish early. The ones that survive rapidly grow, mature, and then experience a period of stability. However, since it becomes increasingly difficult to sustain growth rates over time, many companies eventually ‘die out.’

Finally, Malkiel gives his First Rule, Rule 1:

"A rational investor should be willing to pay a higher price for a share, the larger the growth rate of dividends."

His Corollary to Rule 1:

"A rational investor should be willing to pay a higher price for a share the longer the growth rate is expected to last."