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CFA Level I · CFA Level I Exam

Sources of Equity Returns for CFA Level I

Sources of equity returns explains where a stock's total return comes from: price change plus dividends, and reinvestment of those dividends. Price change can be broken into earnings growth, change in P/E and dividend yield. To solve questions, identify the components, compute each one, then add them, using log or simple returns as the question requires.

What this chapter covers

This chapter asks one question: where does the return on a share come from? The first answer is simple. You earn the price change (capital gain or loss) plus any dividends received. Total return = (P1 − P0 + D1) ÷ P0. Dividend yield is D1 ÷ P0, and price return is (P1 − P0) ÷ P0.

The second layer is decomposition. Price is earnings per share times the P/E multiple, so price change comes from growth in earnings per share and from a change in the P/E. Add the dividend yield and you have three sources: earnings growth, multiple change and income. You also need to see how reinvesting dividends changes the long-run result compared with price return alone.

The third layer is forward-looking. You estimate expected return from these components and relate it to the equity risk premium, which is the extra return investors require over a risk-free rate. This chapter links to Equities (valuation and market efficiency), Portfolio Construction (expected return inputs), Quantitative Methods (returns and compounding) and Corporate Finance (dividend policy). Check the current CFA Institute curriculum for the exact learning outcomes in your module.

The topic weight for Equities is 11-14% of the 2027 exam, and return decomposition is the logic behind many valuation and portfolio questions. The calculations are short, so with three-option MCQs and about 90 seconds per question, this is a chapter where you can bank marks quickly. Questions often combine a simple formula with a wording trap, such as price return versus total return, so careful reading earns points. There is no penalty for wrong answers, so always answer, and good eliminations from sound concepts raise your odds on the harder items.

Sources of Equity Returns: topics in the order to study them

  1. 1Equity Return Components: Price Return and DividendsStart here because every later topic builds on total return = price return + dividend yield.
  2. 2Dividend Yield, Capital Gains and ReinvestmentNext, learn how dividend income and reinvestment change the holding-period result and how to compute each piece.
  3. 3Decomposing Returns: Earnings Growth, P/E and YieldWith the basic components clear, split price change into earnings growth and multiple change using P = EPS × P/E.
  4. 4Expected Return Estimation and Risk PremiumFinish with the forward-looking use, where you combine the components and compare them with a risk-free rate to estimate expected return and the premium.

How to prepare Sources of Equity Returns

Plan for short, repeated sessions that you can fit around work, including on your phone. The calculations are light, so the aim is accuracy and speed.

  1. Write the total return formula from memory and compute price return and dividend yield separately on three or four examples with different currencies, such as USD and EUR.
  2. Practise reinvestment: compute a multi-period value with and without reinvested dividends and note the gap between the two.
  3. Learn the decomposition by hand: write P = EPS × P/E, then show that the growth in price comes from growth in EPS and growth in P/E. Check your answer by recombining the parts.
  4. Learn when a question wants an approximation (adding components) and when it wants an exact multiplicative result. Read the wording before you choose.
  5. Do expected return questions by listing each input: dividend yield, growth, change in valuation and the risk-free rate. Then add or subtract as the question states.
  6. Finish with timed three-option MCQs at about 90 seconds each. For each miss, name the trap and add it to a short error list.
  7. Review your error list and the quick revision points a day before the exam.

Common mistakes in Sources of Equity Returns

  • Giving price return when the question asks for total return.

    Fix: Underline the return type in the stem, then add the dividend yield to the price return before choosing an option.

  • Using the ending price as the base for dividend yield.

    Fix: Use the beginning price P0 for a holding-period return, unless the stem defines yield differently.

  • Treating reinvested dividends as if they earn nothing.

    Fix: When reinvestment is stated, grow each dividend at the stated return or use the price at which shares were bought, and compare ending values.

  • Mixing up earnings growth and price growth in a decomposition.

    Fix: Always write P = EPS × P/E, compute the P/E at both dates, and check that the parts recombine to the price change.

  • Adding components when the question needs a multiplicative result, or the reverse.

    Fix: Use the exact form when the data allow it. Use the additive approximation only when the question points to it, then pick the closest option.

  • Confusing the equity risk premium with total expected return.

    Fix: Subtract the risk-free rate from the expected equity return, and add it back when you need the full return.

Last-day revision: Sources of Equity Returns

  • Total return = price return + dividend yield (for one period, with dividends received at period end).
  • Price return = (P1 − P0) ÷ P0.
  • Dividend yield = D1 ÷ P0, using the starting price unless the question says otherwise.
  • Reinvesting dividends raises ending wealth compared with spending them, so compare total return, not price return.
  • Price = EPS × P/E, so price change comes from EPS growth and P/E change.
  • Return sources: earnings growth, change in P/E, and dividend yield.
  • If the P/E is unchanged, price return equals EPS growth.
  • A rising P/E adds to return, but it cannot be assumed to continue indefinitely.
  • Equity risk premium = expected equity return − risk-free rate.
  • Expected return builds up from income, growth and valuation change.
  • Always check whether a question asks for price return or total return before calculating.
  • Never leave an MCQ blank, as wrong answers carry no penalty.

Sources of Equity Returns practice questions

Sources of Equity Returns in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Sources of Equity Returns: frequently asked questions

What are the main sources of equity returns?

There are two basic sources: price change and dividends. Price change can be broken into earnings growth and change in the P/E multiple, so the three sources are earnings growth, multiple change and dividend yield.

How do I split a stock's return into earnings growth and P/E change?

Write price as EPS × P/E. Compare EPS and P/E at the start and end. The change in price then reflects growth in EPS and change in the multiple, and dividends are added separately for total return.

Does dividend reinvestment matter for the exam?

Yes. Reinvesting dividends buys more shares, which raises ending wealth compared with taking the cash. Read the stem to see whether it asks for price return or total return, and whether reinvestment is stated.

Do I need a calculator for this chapter?

Most questions use simple arithmetic, but the TI BA II Plus or HP 12C helps with multi-period compounding. Practise using it so that you can keep to about 90 seconds per question.