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  • Why do stock prices increase

    Why do stock prices increase?

    The average stock market return for the last 5 years was 11.33%, and for the last 10 years, it was 12.39%.

    While the stock market may seem complex, the returns are actually determined by just two simple elements: investment returns and speculative returns.

    So, what is the investment return?

    Investment return is a combination of earnings and dividend yield. Corporate earnings and dividends provide returns over the long term, forming the basis of stock market gains and serving as the main focus for corporations.

    For example, looking at the S&P 500 for the past 6 years, earnings have been around 4.8%, and dividend yields around 1.6%.

    Earnings and dividend yields for the stock market

    The investment returns total around 6.4% on average. 

    So, why did the S&P 500 return 14.6% on average?

    US stock market average 5 year return

    That brings us to the second component of stock growth – speculative returns.

    The speculative returns on stocks represent the impact of changing public opinion about stock valuations, from optimism to pessimism. Speculative returns represent changes in the price that investors are willing to pay.

    In the past 5 years, the speculative returns impacted more stock pricing than the actual earnings and dividends.

    The speculative return portion is exactly why we see such a huge disparity between the Wall Street predictions for the stock market:

    Wallstreet 2024 prediction

    A study showed that one of the behavioral factors that impact this speculation is actually overconfidence. 

    What’s important to remember is that emotions or speculation have proven to be meaningless in the long term; and the economics of investing (good earnings, profitability) is the one that determines a return over a long period of time. 

    Actionable tip:

    Quality stocks and businesses will determine your long term returns. Even better, just buy the total market index or S&P 500 and build wealth sustainably.

    See you next Saturday.

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