Thus,a firmwitha 5 percent growthrateand a returnon
equityof 15 percentwillhaveastableperiodpayoutratioof
66.67 percent. The othercharacteristics of thefirm in the
stable period should be consistent with the assumption of
stability. For instance, it is reasonable to assume that a
high-growthfirmhasabetaof2,butunreasonabletoassume
thatthisbetawillremainunchangedwhenthefirmbecomes
stable.In fact,theruleofthumbthatwe developedin the
preceding chapter—that stable period betas should be
between0.8and1.2—isworthrepeatinghere.Similarly,the
returnonequity,whichcanbehighduringtheinitialgrowth
phase, should come down to levels commensurate with a
stablefirminthestable-growthphase.Whatisareasonable
stable-periodreturnonequity?Theindustryaveragereturnon
equityandthefirm’sownstable-periodcostofequityprovide
useful information to make this judgment.
Sincethetwo-stagedividenddiscountmodelisbasedontwo
clearly delineated growth stages—high growth and stable
growth—itisbestsuitedforfirmsthatareinhighgrowthand
expecttomaintainthatgrowthrateforaspecifictimeperiod,
afterwhichthesourcesofthehigh growthareexpectedto
disappear.Onescenario,forinstance,wherethismayapplyis
whenacompanyhaspatentrightstoaveryprofitableproduct
forthenextfewyearsandisexpectedtoenjoysupernormal
growth during this period. Once the patent expires, it is
expectedtosettlebackintostablegrowth.Anotherscenario
whereitmaybe reasonabletomake thisassumptionabout
growth is when a firm is in an industry that is enjoying
supernormalgrowthbecausetherearesignificantbarriersto