Long-Run Stock Returns: Participating in the Real Economy

Posted: 4 Apr 2003

See all articles by Roger G. Ibbotson

Roger G. Ibbotson

Yale School of Management; Zebra Capital Management, LLC

Peng Chen

Ibbotson Associates

Abstract

In the study reported here, we estimated the forward-looking long-term equity risk premium by extrapolating the way it has participated in the real economy. We decomposed the 1926-2000 historical equity returns into supply factors-inflation, earnings, dividends, the P/E, the dividend-payout ratio, book value, return on equity, and GDP per capita. Key findings are the following. First, the growth in corporate productivity measured by earnings is in line with the growth of overall economic productivity. Second, P/E increases account for only a small portion of the total return of equity. The bulk of the return is attributable to dividend payments and nominal earnings growth (including inflation and real earnings growth). Third, the increase in the equity market relative to economic productivity can be more than fully attributed to the increase in the P/E. Fourth, a secular decline has occurred in the dividend yield and payout ratio, rendering dividend growth alone a poor measure of corporate profitability and future growth. Our forecast of the equity risk premium is only slightly lower than the pure historical return estimate. We estimate the expected long-term equity risk premium (relative to the long-term government bond yield) to be about 6 percentage points arithmetically and 4 percentage points geometrically.

Keywords: Portfolio Management, Asset Allocation

Suggested Citation

Ibbotson, Roger G. and Chen, Peng, Long-Run Stock Returns: Participating in the Real Economy. Available at SSRN: https://ssrn.com/abstract=390106

Roger G. Ibbotson (Contact Author)

Yale School of Management ( email )

165 Whitney Avenue
P.O. Box 208200
New Haven, CT 06520-8200
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203-432-6021 (Phone)
203-432-6970 (Fax)

Zebra Capital Management, LLC ( email )

2187 Atlantic Street
Stamford, CT 06902
United States
203 701 5900 (Phone)

Peng Chen

Ibbotson Associates ( email )

225 North Michigan Avenue
Suite 700
Chicago, IL 60601
United States
(312) 616-1620 (Phone)
(312) 616-0404 (Fax)

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