Expected return for equites (again)

[Nicholas.Campbell]

Hello,

Could somebody PLEASE help me out on this one...

I just don't get the equation for the expected return for equities:

E[return] = initial income yield + expected capital gain
= initial income yield + (impact of change in yield + income growth)
= (initial income yield + impact of change in yield) + income growth
= dividend yield + income growth
= d + g

Questions
=========

q1) What is the difference because the initial income yield and the dividend yield? I thought the initial income yield was the dividend yield when purchased, so at what point in time is the dividend yield term referring to?

q2) Could someone please give me a working example of this, or better still a proof?

I understand the heuristic argument that the expected capital gain (or price) will be due to yield changes and income growth, but I can't work out the maths behind this!

I have literally wasted hours on this because I cannot move on until I fully understand something!

Thanks,

Nick

 

[Jammy]

I'll take a guess...

Could this have anything to do with the 2 stage model, wherein the 1st stage is a period for which growth rates are forecasted (Eg: 5 years) and 2nd is the period thereafter (6th year to infinity) wherein a constant growth rate is assumed for all years?
The dividends during the 1st period could thus be the initial income yield

PS: I have not studied CA1 yet

 

[Hemant Rupani]

g=capital growth not income growth

So,for equities, the initial income yield is the dividend yield when purchased.

After g=capital growth, you can see workings.

 

[Muppet]

I wouldn't worry about the maths! I think this is more of a general reasonning formula (using a simplified model) than a completely robust relationship. Is the penultimate jump stated anyweher or have you implied it from other text: (initial yield + impact in change)= dividend yield?
As HR says, g usually equals capital growth, although if no change in yield is expected then this will also be income growth. If you can see (intuitively) that the total expected yield is made up up the initial dividend yield, the income growth and any change in yield expected (since this will change the ratio of price:dividend), then I think you're there.

 

[Nicholas.Campbell]

The last jump was actually reasoned by my tutor, maybe it is a perspective thing, initial income yield + expected capital gain being expected return when actually purchased, dividend yield + income growth in general.

I dunno, but g is definitely dividend growth, Hemant

Thanks all for you help tho, like Muppet said, I'll go with general reasoning. I've looked at this formula so many time I know them off by heart anyway!