CFA Level I · CFA Level I Exam · Sources of Equity Returns
An analyst estimates the expected return on a share by adding the expected dividend yield, the expected growth in earnings per share, and the expected change in the price-to-earnings multiple. This approach is best described as a:
The approach decomposes expected return into its component sources: income from dividends, growth in earnings, and re-rating of the P/E multiple. It is not CAPM or a bond-yield-plus-premium method, because neither of those builds the estimate from dividend yield, earnings growth and multiple change.
- ACapital asset pricing model estimate
- BBond-yield-plus-risk-premium estimate
- CDecomposition of return into its sourcesCorrect
Explanation
Splitting expected return into dividend yield, earnings growth and the change in valuation multiple decomposes the return into its sources. CAPM uses a risk-free rate, beta and an equity risk premium. The bond-yield-plus-risk-premium method adds a premium to a bond yield.
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