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Equity returns

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asked Jul 29 in BUS 4027W - Actuarial Risk Management by anonymous

On page 7 of chapter 22, ActEd says that over the long term we expect dividend growth to be close to growth in GDP, assuming that the share of GDP taken by "capital" remains constant.

What does the bold part mean?

1 Answer

+1 vote
answered Jul 31 by PBotha (420 points)


Great question! I will try my best to answer:

One way of expressing the GDP of an economy is by the factors of production: Compensation for Labour (L) + Compensation for Capital (C): i.e. GDP = L + C. 

Compensation for labour is simply put, salaries/wages paid to employees. Compensation for capital is simply dividends paid to investors investing in capital goods.

Say we have a total GDP of R100, split as follows: 20% Capital, 80% Labour in 2017,

And in 2018, the same proportions of Capital and Labour hold, i.e. 20%/80%, but our total economy now has a GDP of R110 - i.e. a 10% growth. Calculate what the growth in capital was: i.e. it is still 20% of the economy (0.2*110 = 22) --> growth is 2 --> 10% dividend growth - same as total economy growth. (This is what we EXPECT if the proportions remain constant).

However, the proportion of C & L of total GDP can change and when this changes it distorts the relationship between GDP growth and dividend growth, because now more or less of this growth is attributable to the capital component. i.e. investment can increase/decrease relative to productivity (labour), and the relative levels of return/growth will differ and not equal the overall GDP anymore.

Note that GDP can also be expressed differently - in terms of output (and not input as above). But this is just for interest's sake: GDP = C + I + G + (X – M) or GDP = private consumption + gross investment + government investment +government spending + (exports – imports).