Ratio of earnings decline for each percentage decline in interest rates

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packer16
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Ratio of earnings decline for each percentage decline in interest rates

Post by packer16 » Tue Aug 13, 2019 7:44 am

I have heard stated that a decline in interest rates is the result of lower expected earnings growth. I generally agree with this statement. We are also seeing is a wider ERP as interest rates are falling, see Damodaran's data. This would imply that lower interest rates are more than offset by lower growth rates in the pricing of equities. On the other hand, you folks like Buffet who has said that if interest rates are this cheap stocks are a bargain (which would imply the effects of a decline in interest rates is not totally offset by lower growth). Is there any data that anyone that has seen that would show historically if the decline in interest rates is more than offset subsequent lower earnings growth? TIA

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JoMoney
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Re: Ratio of earnings decline for each percentage decline in interest rates

Post by JoMoney » Tue Aug 13, 2019 8:25 am

You should look at (Earnings Growth + Dividend Yield) since both are important component of the return.
You wouldn't look at bond returns without including the coupon. A company was able to have their earnings growth while still paying out the dividend.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

alex_686
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Re: Ratio of earnings decline for each percentage decline in interest rates

Post by alex_686 » Tue Aug 13, 2019 8:41 am

The common formulation is:

Equity Return = Risk Free Rate (Long Term Government Bond) + Equity Risk Premium.

It is well studied and generally accepted, with the acknowledgement that ERP is hard to measure.

Try googling Yardeni Ratio as a starting point.

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