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Equity Premium

Governments are largely insulated from market forces. Companies are not. Investments in stocks therefore carry substantial risk in comparison with holdings of government bonds, notes or bills. The marketplace presumably rewards risk with extra return. How much of a return premium should investors in equities expect? These blog entries examine the equity risk premium as a return benchmark for equity investors.

Worldwide Equity Returns in the 21st Century

In his June 2006 article entitled “Investing in the 21st Century: With Occam’s Razor and Bogle’s Wit”, Javier Estrada evaluates the long-term forecasting abilities of two simple models over 10-year periods during 1973-2005. He then uses them to predict the returns for 12 country stock markets (Australia, Belgium, Canada, Denmark, France, Germany, Ireland, Japan, Netherlands, Switzerland, UK, USA) for 2006-2015. He finds that: Keep Reading

Classic Research: Stock Returns in the Long Run

We have selected for retrospective review a few all-time “best selling” research papers of the past few years from the General Financial Markets category of the Social Science Research Network (SSRN). Here we summarize the March 2002 paper entitled “Stock Market Returns in the Long Run: Participating in the Real Economy” (download count over 3,400) by Roger Ibbotson and Peng Chen. The authors examine the relationships during 1926-2000 between historical equity returns and key supply side factors such as inflation, earnings, dividends, price-to-earnings ratio (P/E), dividend payout ratio, book value, return on equity and GDP per capita. They extrapolate these supply side connections with the real economy to estimate the future long-term equity risk premium. They conclude that: Keep Reading

4% Solution: Equity Risk Premium Update

In their May 2005 paper entitled “The Market Equity Risk Premium”, Brian McCulloch and Dasha Leonova present a comprehensive review of equity risk premium research to support decision-making regarding the annual capital contribution to New Zealand Superannuation Fund, a government-managed pension fund. They seek the best estimate of the future annual premium of nominal long-term equity returns over nominal long-term bond returns. Based on international experiences and forecasts over many decades, they conclude that: Keep Reading

The Best Benchmarkers, Ever!

In their April 2005 draft of “History and the Equity Risk Premium”, two pioneers in the definition and measurement of the equity risk premium, William Goetzmann and Roger Ibbotson, recount the history of this essential benchmark for stock investment returns. Then, they update their estimate of its value for U.S. equities over the past two centuries. Their conclusions are: Keep Reading

Triumph of the Optimists (Chapter-by-Chapter Review)

Triumph of the Optimists: 101 Years of Global Investment Returns by Dimson, Marsh and Staunton (2002) is thorough, logical and concise. With scores of illustrative graphs and figures, its statistics are accessible and its style straightforward. Its message, however, is somewhat at odds with the title. Below is a chapter-by-chapter review of the insights in this book: Keep Reading

One Up on the Fed Model?

In their June 2003 paper entitled “A General Theory of Stock Market Valuation and Return”, Christophe Faugere and Julian Van Erlach contend that past stock returns are overstated and develop a market valuation formula that out-fits the Fed Model. Specifically, they show that: Keep Reading

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