value
Yield Plus Growth
The rule
Over many years, a market earns you roughly its dividend yield today plus how much those dividends grow. Pay a high price and your future return shrinks.
Where it flips
The formula assumes dividends and payout habits stay fairly steady. It breaks when firms buy back shares instead of paying out, or in a real growth shift. So treat it as a slow, decade-long anchor, not a forecast for any one year. And check the growth number honestly, rather than raise it just to excuse a high price.
You do not have to guess the future to estimate what an index will earn over many years. Take the dividend yield you can buy right now. Add the rate at which those dividends grow, after removing rising prices. That sum is a fair guess for the long-run return. Here is the key point. The price you pay sets the yield you get. Pay more for the same dividends, and your future return falls. Pay less, and it rises.
A worked example
Rohan sees the Nifty giving about 1.5% in dividends and expects real dividend growth near 5%. So he pencils a long-run return around 6.5%. He refuses to believe the 15% a salesman promised. [illustrative]
How to spot it
- ·a return promise far above yield plus sane growth
- ·nobody mentions the current dividend yield
- ·growth assumed to run forever
William Bernstein · The Four Pillars of Investing