Issue 3, 2005

Sharp P. A. The Expected Rate of Return on the U. S. Stock Market: Estimation for Coming Decade

This paper employs a non constant growth dividend discount model to estimate expected returns on investment in the equity market. The model creates optimistic, normal, and pessimistic forecasts of growth in dividends and earnings per share by using high, median, and low periods of historical growth. Even optimistic assumptions about future growth in earnings and dividends produce expected real rates of return below the historical real rates of return on equity for the coming decade. Expected rates of return for the coming decade approach the long run historical average rate only if one assumes an expected decline in the future required rate of return on equity at the end of the decade and when stock repurchases are assumed to increase dividend growth above their historical norms. The results admit to four possibilities. First, the expected returns on equity for the coming decade are much lower than they have been historically. Second, future growth rates in earnings and dividends will be higher than even high historical periods. Third, required rates of return will decline and produce capital gains that temporarily maintain returns on equity. The fourth possibility is that the dividend discount model is not appropriate to use to assess equity values and returns on equity.

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