1. Explain why analysts’ forecast of earnings-per-share growth typically underestimate the growth that an investor values if a firm pays dividends.
2. The historical earnings growth rate for the S&P 500 companies has been around 8.5%. Yet the required growth rate for equity investors is considered to be about 10%. Can you explain the inconsistency?
3. The following formula is often used to value shares, where
is the value of equity at Time 0,
is forward earnings at Time 1,
is the required rate of return (cost of capital),
is the expected earnings growth rate.
Explain why this formula can lead to errors.