A decrease in the earnings retention rate will increase the following expression for P/S due to the implied increase in the payout ratio, which is (1 – b):
P0 / S0 = [(E0 / S0)(1 – b)(1 + g)] / (r – g)
Note that the topic review does not allow for any interactive relationship between retention and growth. Thus, no explicit consideration is given to whether the increase in the payout ratio will cause an offsetting decrease in growth.
