Chase),arealestateinvestmenttrust(REIT)(Vornado),anda
telecommunications firm (Verizon). The following table
summarizes the returns on equity, retention ratios, and
expected growth rates in earnings for the four firms
(assuming that they can maintain their existing fundamentals).
Goldman Sachs has the highest expected growth rate in
earningspersharebecauseofitshigh returnonequityand
retentionratio.Verizonhasthehighestreturnonequity,but
retainslessofitsearnings,leadingtoalowerexpectedgrowth
rate.JPMorgan Chase’slow returnonequityand retention
ratioactasadrag onexpectedgrowth, whereasVornado’s
expectedgrowthrateisdepressedbytherequirementthatit
pay out most of its earnings as dividends.
Growth in Net Income
Ifwerelaxtheassumptionthattheonlysourceofequityis
retainedearnings,thegrowthinnetincomecanbedifferent
fromthegrowthinearningspershare.Intuitively,notethata
firmcangrownetincomesignificantlybyissuingnewshares
tofundnewprojectswhileearningspersharestagnates.To
derive the relationship between net income growth and
fundamentals, weneed a measure of investment that goes
beyondretainedearnings.Onewaytoobtainsuchameasure
is to estimatedirectlyhow muchequitythe firmreinvests
backintoitsbusinessesintheformofnetcapitalexpenditures
and investments in working capital.