productofthereturnonequityinperiodtandtheretention
ratio.
Whileincreasingreturnonequitywillgenerateaspurtinthe
growthrateintheperiodoftheimprovement,adeclineinthe
returnonequitywillcreateamorethanproportionaldropin
the growth rate in the period of the decline.
It is worth differentiatingatthis point betweenreturns on
equityonnewinvestmentsandreturnsonequityonexisting
investments. The additional growth that we are estimating
comesnotfromimprovingreturnsonnewinvestmentsbutby
changing thereturnonexisting investments. Forlack ofa
better term, you could consider it “efficiency-generated
growth.”
ILLUSTRATION4.6:EffectsofChangingReturnonEquity:
JPMorgan Chase
InIllustration4.3,welookedatChase’sexpectedgrowthrate
basedonitsreturnonequityof11.16%anditsretentionratio
of34.62%.Assumethatthefirmwillbeabletoimproveits
overall return on equity (on both new and existing
investments) to 12% nextyearand that theretention ratio
remainsat34.62%.Theexpectedgrowthrateinearningsper
share next year can then be written as: