{"id":1885691,"date":"2013-12-24T12:45:19","date_gmt":"2013-12-24T07:15:19","guid":{"rendered":"http:\/\/stockviz.biz\/index.php\/?p=1885691"},"modified":"2013-12-24T12:49:19","modified_gmt":"2013-12-24T07:19:19","slug":"where-do-returns-come-from","status":"publish","type":"post","link":"https:\/\/stockviz.biz\/index.php\/2013\/12\/24\/where-do-returns-come-from\/","title":{"rendered":"Where do returns come from?"},"content":{"rendered":"

Philosophical Economics<\/a> has a gem of a piece out on what influences total return.<\/p>\n

Total returns on holding equity securities come from:<\/p>\n

    \n
  1. the change in price from purchase to sale, and<\/li>\n
  2. the dividends paid in the interim<\/li>\n<\/ol>\n

    i.e. Total Return = Price Return + Dividend Return<\/strong>
    \n <\/p>\n

    Price Return<\/strong> =<\/p>\n

    Price Return from P\/E Multiple Change
    \n+<\/strong> Price Return from Earnings Growth (Realized if P\/E Multiple Were to Stay Constant)<\/p>\n

     <\/p>\n

    Stock prices don’t change because market participants choose to assign stocks different P\/E multiples. Rather, they change because the eagerness of the aggregate investment community to allocate wealth into stocks rises or falls. More investors try to “put money to work” than try to “take money off the table”, and vice-versa. In the presence of the imbalance, the price has no choice but to change.<\/p><\/blockquote>\n

     <\/p>\n

    So, Price Return<\/strong> =<\/p>\n

    Price Return from Change in Aggregate Investor Allocation to Stocks
    \n+<\/strong> Price Return from Increase in Cash-Bond Supply (Realized if Aggregate Investor Allocation to Stocks Were to Stay Constant)<\/p>\n

     <\/p>\n

    For a given set of environmental contingencies\u2013e.g., history, culture, demographics, etc.\u2013the equity allocation preference is mean reverting. It rises in expansionary parts of the cycle, as people become more optimistic about the future and more eager to maximize what they see as attractive returns, and it falls in contractionary parts of the cycle, as people become less optimistic about the future and more concerned about protecting themselves from losses.<\/p><\/blockquote>\n

     <\/p>\n

    This is also backed up by another piece of research that shows that in the long-run, economic growth and stock market returns are negatively, not positively, correlated. Why? Because investors routinely appear to overpay for growth. Besides stock returns is determined by earnings growth per share, not economy-wide corporate earnings growth. The two can vary markedly.<\/p>\n

    \"equity<\/a><\/p>\n

    In other words, investors should invest more in equities when the economy is in the shitter and exit when they hear “India Shining” ads.
    \n<\/em><\/p>\n

     <\/p>\n

    Source:
    \n    The Single Greatest Predictor of Future Stock Market Returns<\/a>
    \n    Rising GDP not always a boon for equities<\/a><\/p>\n

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