Decomposing Equity Returns: Earnings Growth vs. Multiple Expansion

Abstract

This short article decomposes equity returns into earnings growth and multiple expansion to help understand why most markets and styles have been lagging and are now cheap compared to the US equity market. The breakdown uncovers differing reasons for underperformance: small-cap and low-volatility stocks have delivered solid earnings growth but lagged due to stagnant valuations, while Emerging Markets equities have suffered from weak earnings growth despite rising valuations. For a turnaround, Emerging Markets equities primarily need improved operating performance, especially in China, Korea, and EMEA, while small-cap and low-volatility stocks do not really have a profitability problem but need to regain favor among investors.