It also represents what you would earn from investing in a guaranteed (or at least as close as you can get to guaranteed) investment instead of trendy boutique s. If the equity risk premium is the receptacle for all of the fears and hopes that equity investors have about the future, the lower that premium, the more they will be willing to pay for stocks. Thus, while history can sometimes yield skewed values (up or down) on growth and analysts can become overly optimistic or pessimistic, the intrinsic growth rate will be grounded in reality. If it is, then the equity reinvestment rate and ROE are both over stated, and the expected growth rate will be lower. This premium will be shaped by investor perceptions of the macro economic risk that they face from investing in stocks. Here is the first of three stocks being added to the experimentation, EXFO Incorporated as it closed today 11/10/20 at $2.6650 a share.
Expected growth: The bonus of investing in equity, as opposed to fixed income, is that you get to share in the growth that occurs in earnings and cash flows in future periods. Sustainability: Are analysts over estimating earnings growth? Over the last 5 years, the compounded average annual growth rate in aggregate earnings for the S&P 500 has been 4.42%. As the most widely followed index in the world, analyst estimates of growth in earnings are widely available both for individual companies in the S&P 500 index and for aggregate earnings in the index. Second, the cash returned in 2012 may have been a historic high in dollar value terms, but as a percent of the index, it is close to the average yield over the last decade. Over the entire 50 year time period, there have been only four years (1962, 1973-1975) where the average returns were negative, and there are periods, such as the late 1990s, where the average return is close to 100% (doubling of price on the offering date). Risk free rate: The risk free rate operates as more than base from which you build expected returns as investors. While it has been less than five years since the crisis of 2008 and the epic collapse of equities in the last quarter of that year, the returns earned by those who stayed the course, even relative to pre-crisis price levels, is a testimonial to the dangers of staying out of equity markets for extended periods.
Last quarter was a minefield for corporations. In my post from the end of last year, I had reported on an intrinsic valuation of Apple of $609/share, using data as of December 2012, with a distribution of values in a later post. Level: In the most recent twelve months for which data is available (through December 2012), the companies in the S&P 500 bought back almost $400 billion worth of stock, much more than the $270 billion that they paid out in dividends. Third, the aggregate cash balances at the S&P 500 company amounted to 10.66% of firm value at the end of 2012, suggesting that companies have cash on hand to sustain and perhaps even increase cash returned to stockholders. While there are some strict value investors who believe that dividends are qualitatively better than buybacks, because they are less volatile, the aggregate amount returned by US companies in buybacks is too large to be ignored.