In book "A Random Walk Down Wall Street" I came across the calculation of long-term equity return which was
long-run equity return = Initial dividend yield + growth rate
Where the growth rate, as the author explained subsequently, being
growth of earnings and dividend
This kind of made sense to me since I suppose (return = rate of growth in stock price + dividend yield) and if assuming P/E ratio being constant, the rate of growth in stock price is just the rate of growth in EPS. However, the author explained in an example later how to adjust for change in P/E ratio, which is basically adding the rate of change in P/E into the equation. So the new equation, according to the author, is
rate of return = initial dividend yield + growth rate + rate of change in P/E
I was trying to work out the math but I got (return = initial dividend yield + growth rate + rate of change in P/E * (future EPS / current EPS)). Feel like I'm getting something wrong somewhere. Can anyone please explain the math behind it please? Thx.
