A General Theory of Stock Market Valuation and Return
AbstractWe show that the long-term total market and average investor's compounded stock returns are determined by GDP growth and are much less than believed because of the infeasible assumption that dividends can be fully reinvested. The long-term stock return closely approximates the return on risk-free debt, thus yielding a zero premium on a compounded per-capita basis. We demonstrate that the market earnings yield ratio (inverse P/E) is akin to a minimum nominal expected return and a direct function of inflation and a real required yield equal to long-term real GDP per capita growth, with marginal regard to risk. Our derived valuation formula is tested against the S&P 500 index and produces a 21% mean percentage tracking error, compared to 32% for the 'Fed Model' over the period 1954 - 2002.
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Bibliographic InfoPaper provided by EconWPA in its series Finance with number 0403004.
Length: 32 pages
Date of creation: 22 Mar 2004
Date of revision: 17 May 2004
Note: Type of Document - pdf; pages: 32
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Required yield; Earnings yield; Equity Premium; S&P 500 Valuation; Fed Model.;
Other versions of this item:
- Christophe Faugere & Julian Van Erlach, 2003. "A General Theory of Stock Market Valuation and Return," Finance 0311005, EconWPA, revised 17 May 2004.
- G - Financial Economics
This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-03-28 (All new papers)
- NEP-CFN-2004-03-28 (Corporate Finance)
- NEP-FIN-2004-03-28 (Finance)
- NEP-FMK-2004-03-28 (Financial Markets)
- NEP-RMG-2004-03-28 (Risk Management)
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