Syndicate
Data and Methodology
Verification will not be direct, since the equation has two variables and we need to try to isolate the effect of each one of them. For example, it could be that the PER goes up because the interest rate goes down, and at the same time the growth increases. In this case, habitual on the other hand, we wouldn’t know if the increase of the PER is due to the reduction of rates or to the growth expectations. However we will try.
We know that the market PER we pay is directly related with the interest rate and with the risk premium that we ask for from the investment. For example if the bonds are at 4 for 100 and the risk premium we ask for from the share is of 5 for 100, we will ask from our investment a profit share of 9 for 100, and to obtain it will have to buy a PER of 1/9 for 100 = 11. This is the maximum PER we would pay, under the hypothesis that the benefits of the companies that quote in the index are not going to increase.
But let us go to the market and the stock exchange index quote, for example at a PER of 20. Why is the market paying more than what had initially been foreseen? Well, because it hopes the profits will grow and it is willing to pay an extra amount (the difference between PER of 20 and PER of 11) because of the expectations of growth of profit. In the difference between the market PER (20 in our example) and the PER explained by the interest rate & risk premium, we will call it PER growth.