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

Over five years, a company's earnings grow at 8% a year, and its P/E ratio rises from 12 to 16. The company pays no dividends. The annualized price return is closest to:

The annualized price return is about 14.5%. Earnings compound at 8% a year, giving a factor of about 1.469 over five years, and the P/E expands by 1.333. Multiplying gives about 1.959, whose fifth root is roughly 1.144, so the annual return is near 14.5%.

  1. A8.0%
  2. B14.5%Correct
  3. C16.0%

Explanation

Earnings factor = 1.08^5 = 1.4693. P/E factor = 16/12 = 1.3333. Price factor = 1.9591. Annualized = 1.9591^(0.2) - 1: ln 1.9591 = 0.6724, /5 = 0.13448, exp = 1.1440, about 14.4-14.5%. Option A ignores the multiple expansion; C is mere arithmetic addition wrongly done.

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