Analyzing and Estimating Real Stock Returns

Abstract

What is the likelihood that real stock returns will average approximately 7% in the future, as they have done in the past? The author addresses this issue by analyzing the components of real stock returns over the period 1926 to 2005. The analysis allows investors to both understand real stock returns and make informed estimates of average real returns going forward. Although the typical case being made today for lower stock returns in the future is apparent, given today's significantly lower dividend yield, the author explores the conditions under which real returns can continue at their historical average. Using this framework, investors can easily substitute their expectations about real earnings growth and market valuations into the model to make intelligent estimates of average real returns over some future period.