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Monday, January 17, 2005

 

Total Return Components

Total Return is yield %, plus price return %.

Price P is E.(P/E) or D.(P/D) or B.(P/B). Thus, the price % return itself can be broken down into two components:

* growth % + (P/*) ratio growth %.

While return components are simply added as first approximation, only logarithmic returns [log (1+return %/100] should be added.

Total Return can then be broken down into three components:

yield % + Earning Growth % + (P/E) Ratio growth %
or
yield % + Dividend Growth % + (P/D) Ratio growth %
or
yield% + Book Value Growth % + (P/B) Ratio Growth %
etc.

For stocks, indices and funds, one of these may be more appropriate.

Dividends are most reliable for established/mature companies and stock indices.

Earnings are readily available for indices and growth stocks.

Book values may be available for indices, mature companies and those undergoing restructuring.

Earnings and dividends can be for training 12 months, or for projections, estimated for future 12 months.

Over very long periods, (P/*) ratio growth % becomes small. Thus, very long term returns tend to be stable, and are simply,

yield % + Earning growth %
or
yield % + Dividend growth %
or
yield % + Book value growth %

Over intermediate term, changes in (P/*) ratios contribute significantly to total return.

Over short term, changes in * and in (P/*) ratios contribute heavily to total return.

This is why time-diversification is important and why dollar-cost-averaging usually works.

YBB





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