CFA Level I · CFA Level I Exam · Sources of Equity Returns
Over a decade, a market's price index rose faster than its earnings. Holding dividend yield constant, which of the following is the most likely explanation?
The most likely explanation is that the price-to-earnings multiple expanded. Because price equals P/E times earnings per share, prices can only grow faster than earnings if the multiple rises, which reflects re-rating by investors.
- AThe dividend payout ratio fell to zero
- BThe price-to-earnings multiple expanded over the periodCorrect
- CEarnings growth exceeded the growth in prices
Explanation
Price = P/E × EPS, so if price grows faster than earnings, the P/E multiple must have risen (re-rating). Option C contradicts the premise. Option A is not implied by price outpacing earnings.
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