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Jay Ritter asks in a new paper whether economic growth is good for investors
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« Global Multi-Asset Market Portfolio 1959-2011"Apple has just spent about 30% more than Intel. And it spent three times in Q3 than Google, 4.8x Microsoft and 3.8x Amazon" »

Jay Ritter asks in a new paper whether economic growth is good for investors

11/01/12


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Jay Ritter asks in a new paper whether economic growth is good for investors

Permalink 11:29:48 am, by editor of MarketObservation.com Email , 436 words   English (US)

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Categories: Investment

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Strong Share buy back activity is a logical consequence in an environment of shareholder value maximization and modest innovation. Consequently, we need policies which foster quality innovation and not The Great Stagnation.

Jay Ritter has some insights on the relationship between economic growth and investor returns:

Ritter, Jay R., Is Economic Growth Good for Investors? (Summer 2012). Journal of Applied Corporate Finance, Vol. 24, Issue 3, pp. 8-18, 2012. Available at SSRN: http://ssrn.com/abstract=2161183 or http://dx.doi.org/10.1111/j.1745-6622.2012.00385.x

Abstract:

"When measured over long periods of time, the correlation of countries' inflation-adjusted per capita GDP growth and stock returns is negative. This result holds for both developed countries (for which the correlation coefficient is ¨C0.39 using data from 1900¨C2011) and emerging markets (the correlation is ¨C0.41 over the period 1988¨C2011). And this means that investors would have been better off investing in countries with lower per capita GDP growth than in countries experiencing the highest growth rates. This seems surprising since economic growth is generally assumed to be good for corporate profits. In attempting to explain this finding, the author begins by noting that economic growth can be achieved through increased inputs of capital and labor, which don't necessarily benefit the stockholders of existing companies. Growth also comes from technological advances, which do not necessarily lead to higher profits since competition among firms often results in the benefits accruing to consumers and workers. What's more, it's important to recognize that growth has both an expected and an unexpected component. And one explanation for the negative correlation between growth and stock returns is the tendency for investors to overpay for expected growth. But there is another - and in the author's view, a more important - part of the explanation. Along with the negative correlation between long run average stock returns and per capita growth rates, the author also reports a strong positive association between (per share) dividend growth rates and overall stock returns. Such an association is not surprising since unusual growth in dividends is a fairly reliable predictor of increases in future earnings. But another effect at work here is the role of dividends - and, in the U.S., stock repurchases too - in limiting what might be called the corporate overinvestment problem, the natural tendency of corporate managers to pursue growth, if necessary at the expense of profitability. One of the main messages of this article is that corporate growth adds value only when companies reinvest their earnings in projects that are expected to earn at least their cost of capital - while at the same time committing to return excess cash and capital to their shareholders through dividends and stock buybacks." Source: SSRN

Keywords: Economic Growth, Returns


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