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CFA Level I · CFA Level I Exam · Sources of Equity Returns

An analyst argues that the contribution of P/E expansion to equity returns is least likely to be sustainable over long horizons. The most appropriate reason is that:

Multiples cannot expand indefinitely, so over long horizons equity returns depend mainly on earnings growth and income such as dividends and buybacks. P/E expansion can boost returns for a time but is a temporary repricing, not a persistent source of return.

  1. Adividend yields cannot be negative
  2. Bmultiples cannot expand indefinitely, so long-run returns depend mainly on earnings growth and incomeCorrect
  3. Cearnings growth is always lower than the change in the P/E ratio

Explanation

A rising P/E cannot continue forever because valuations would become implausibly high; over long periods returns are driven by earnings growth and income. The other statements are irrelevant or incorrect generalizations.

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