How To Think About The Sources Of Investment Returns

In terms of a somewhat succinct summary, it is good to think in terms of trade-offs in the full picture. The expected returns formula I use really summarizes things neatly, and makes you think about how changes in the different variables impact overall results over a given time period. The expected returns formula is a function of:

1. Dividends

2. Earnings Per Share Growth

3. Changes in valuation

I am using this additional step in the exercise, because quite often I see folks whose whole analysis stems from looking at a price chart and making up their mind from it. This is dangerous in my opinion, because you need to understand the context and reasons of why what happened happened. And from them to determine if it can happen further in the future, or not.

One needs to look at these three items together, rather than in isolation, when it comes to understanding where returns come from.

This post originally appeared at Dividend Growth Investor.