Re: Return on investment vs economic growth

From: sinister (sinister_at_nospam.invalid)
Date: 11/04/04 

Date: Thu, 04 Nov 2004 23:01:32 GMT

"Dez Akin" <dezakin@usa.net> wrote in message
news:dd43b4da.0411041156.383967e9@posting.google.com...
> Three years ago I asked why there was a discrepency between economic
> growth and growth of an investment in the stock market, and I think I
> was a little to readily satisfied with the answer. It still is a
> little perplexing that you can get a better after inflation return on
> your investment than the rate of economic growth (7-10% versus 3-4%)

The answer to the paradox is as follows:
The return on a stock comprises, according to the Gordon equation, 3 parts:
* The inital payout (dividend-to-price, or D/P)
* The rate of dividend growth
* The change in P/E ratio

In the steady state, we can assume the last is zero.

The proper comparison isn't the economic growth rate to the total return on
a stock (annualized), i.e., initial payout PLUS dividend growth rate. If
you look at the details, that's an apples-to-oranges comparison. The proper
comparison is economic growth versus dividend growth rate.

Clearly in the long run, neither earnings nor dividends can grow faster than
the economy.

There's stuff written on this at efficientfrontier.com. In particular, one
of his essays concerns the "slippage" between dividends or earnings growth
rates and economic growth rates.

> What is the relationship between economic growth and return on stock
> market, or any other investments. In a hypothetical economy where
> there is net growth of zero, would you still have a positive average
> return on investment?

Yes; the dividend payout ratio.

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