Stock Return Expectations and P/E10

Abstract

Benson, Bortner, and Kong estimate the return on equities using the matrix approach suggested by Bogle in 1991. In addition to Bogle’s approach, the authors incorporate share repurchases as suggested by Grinold and Kroner in 2002 and by Shiller’s P/E10.They demonstrate that this relatively simple approach provides reasonable estimates of subsequent 10-year returns for the S&P 500 Index. The authors also focus on the relationship between the P/E10 ratio and the market’s subsequent return. The authors demonstrate that when P/E10 is at low (high) levels in its historic range, the subsequent average 10-year market returns are relatively high (low or negative). When subsequent 3- and 5-year returns are examined, the relationship between P/E10 and subsequent average annual returns is even stronger. Finally, the authors’ analysis suggests that the demonstrated approach may be used to estimate returns for various market sectors or indices by applying the approach to estimating the returns on three Russell indices.

TOPICS: Security analysis and valuation, equity portfolio management, performance measurement