Final answer:
When evaluating a firm's investment potential, both dividend payout and capital gains should be considered. Historically, dividend rates have decreased from about 4% to 1%-2% of stock value, making capital gains a more significant contributor to total expected returns. A firm's projected 7% growth in dividends can affect an investor's total ROI along with stock value appreciation.
Step-by-step explanation:
Understanding Stock Value and Dividends
When analyzing a firm's investment potential, one must consider both the dividend payout and the potential for capital gains. Historically, companies in the S&P 500 index have provided returns to investors in the form of dividends and stock value appreciation. In the past, firms paid out dividends around 4% of their stock value, but that figure has since decreased to about 1% to 2% since the 1990s.
The potential for capital gains has played a more predominant role in the expected rate of return for investors, especially from the 1980s onward, where growth in stock value often outpaced dividend payouts. Capital gains are realized when an investor buys a stock at a lower price and sells it at a higher price, such as purchasing a Wal-Mart stock at $45 and selling it at $60.
For a firm projecting dividend growth of 7%, the investor would be looking at future dividend payments increasing annually at this rate, contributing to the total rate of return alongside possible capital gains. The interplay between dividends and stock price appreciation is crucial when assessing the overall return on investment (ROI) in the stock market.