Using the Supply Side Approach to Understand and Estimate Stock Returns

This paper uses the supply side approach developed by Ibbotson and Chen to analyze average stock returns for the period 1926-2004. Using the quot;earningsquot; model variation, it is easy to see how each component, including real earnings growth and the P/E ratio, contributed to the average total return on stocks. We estimate the long-run, sustainable average equity return as a benchmark expected equity return. Our innovation is to show how this model can be used by investors as a disciplined framework for estimating average equity returns over shorter periods of time. We illustrate how this can be done and note the assumptions and implications involved