Where stock returns come from

A share's return in any one year is not one number, it is three added together. Two of them come from the business itself, and the third comes from how the market's opinion of it changed.

Three moving parts

Bogle, in The Little Book of Common Sense Investing, split the stock market's long-run return into two kinds. The same split works for one share in one year. Investment return is the dividend yield plus the growth in earnings per share, both of which come from the business doing more or less well. Speculative return is the change in the price multiple, which reflects what the crowd will pay for the same dollar of earnings, not any change in the earnings themselves.

The multiple is the market's part

Over one year, the multiple can swing further than the business does. A steady company can see its P/E move from 20 to 15, or to 25, with nothing in its filings changed, because rates or the market's mood shifted. The dividend and the earnings growth are comparatively slow, and are the parts a company's own filed results actually explain from one year to the next. The multiple is the part the market sets on its own, apart from anything the company filed.

What moves a multiple

The market's multiple for a company reflects more than a passing mood. Interest rates, how fast profit is expected to grow, and how safe that growth feels all show up in the same number, and all three can shift together within a single year. That is what makes the third part of the return the hardest of the three to predict in advance, not that it moves for no reason at all.

Why the split is worth keeping

Splitting the return this way is a habit worth keeping before you own anything. A return built mostly from earnings growth says something about the business. A return built mostly from a rising multiple says something about how the market's opinion changed, and an opinion can reverse as easily as it formed.

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