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Earnings Growth: The Two Percent Dilution

Posted: 26 Jan 2004  

William J. Bernstein

Frontier Advisors

Robert D. Arnott

Research Affiliates, LLC

Abstract

Two important concepts played a key role in the bull market of the 1990s. Both represent fundamental flaws in logic. Both are demonstrably untrue. First, many investors believed that earnings could grow faster than the macroeconomy. In fact, earnings must grow slower than GDP because the growth of existing enterprises contributes only part of GDP growth; the role of entrepreneurial capitalism, the creation of new enterprises, is a key driver of GDP growth, and it does not contribute to the growth in earnings and dividends of existing enterprises. During the 20th century, growth in stock prices and dividends was 2 percent less than underlying macroeconomic growth. Second, many investors believed that stock buybacks would permit earnings to grow faster than GDP. The important metric is not the volume of buybacks, however, but net buybacks - stock buybacks less new share issuance, whether in existing enterprises or through IPOs. We demonstrate, using two methodologies, that during the 20th century, new share issuance in many nations almost always exceeded stock buybacks by an average of 2 percent or more a year.

Keywords: Portfolio Management, asset allocation, Economics, macroeconomics, Investment Industry, future directions and sources of change

Suggested Citation

Bernstein, William J. and Arnott, Robert D., Earnings Growth: The Two Percent Dilution. Financial Analysts Journal, Vol. 59, No. 5, pp. 47-55, September/October 2003. Available at SSRN: https://ssrn.com/abstract=489602

William J. Bernstein (Contact Author)

Frontier Advisors ( email )

1890 Waite Dr. Suite 3
North Bend, 97459
541-756-0668 (Phone)
541-756-3774 (Fax)

Robert D. Arnott

Research Affiliates, LLC ( email )

620 Newport Center Dr
Ste 900
Newport Beach, CA 92660
United States
949-325-8700 (Phone)
949-325-8901 (Fax)

HOME PAGE: http://www.researchaffiliates.com/Our%20Firm/Our%20Team/Pages/Rob-Arnott.aspx

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