Grinold and Kroner Model
Encyclopedia
The Grinold and Kroner Model is used to calculate expected returns for a stock
, stock index
or the market as whole. It is a part of a larger framework for making forecasts about market expectations.
The model states that:
Expected Returns= Div1 /P0 + i + g - ΔS + Δ (P/E)
Div1 = dividend
in next period (period 1 assuming current t=0)
P0 = current price (price at time 0)
i= expected inflation
rate
g= real growth rate in earnings (note that by adding real growth and inflation, this is basically identical to just adding nominal growth)
ΔS= changes in shares outstanding (i.e. increases in shares outstanding decrease expected returns)
Δ(P/E)= changes in P/E ratio (positive relationship between changes in P/e and expected returns).
One offshoot of this discounted cash flow analysis is the Fed Model. Under the Fed model, the earnings yield is compared to the 10-year treasury bonds. If the earnings yield is lower than that of the bonds, the investor would shift her money into the less risky T-bonds.
Stock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...
, stock index
Stock market index
A stock market index is a method of measuring a section of the stock market. Many indices are cited by news or financial services firms and are used as benchmarks, to measure the performance of portfolios such as mutual funds....
or the market as whole. It is a part of a larger framework for making forecasts about market expectations.
The model states that:
Expected Returns= Div1 /P0 + i + g - ΔS + Δ (P/E)
Div1 = dividend
Dividend
Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be distributed to...
in next period (period 1 assuming current t=0)
P0 = current price (price at time 0)
i= expected inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
rate
g= real growth rate in earnings (note that by adding real growth and inflation, this is basically identical to just adding nominal growth)
ΔS= changes in shares outstanding (i.e. increases in shares outstanding decrease expected returns)
Δ(P/E)= changes in P/E ratio (positive relationship between changes in P/e and expected returns).
One offshoot of this discounted cash flow analysis is the Fed Model. Under the Fed model, the earnings yield is compared to the 10-year treasury bonds. If the earnings yield is lower than that of the bonds, the investor would shift her money into the less risky T-bonds.