Equity compounded annual growth rate (%) 11.2 Equity risk premium (%) 5.3 Dividend yield (%) 4.0 Equity repurchase yield (%) –0.5 Nominal earnings growth return (%) 4.6 Current and Forward Looking Data Current equity price-to-earnings ratio 14.6 Expected equities real earnings growth rate (%) 2.7 Expected long-term inflation rate (%) 2.5 Solution:
Income return is the sum of the dividend yield (i.e., D/P, which is 4.0%) and the equity repurchase yield (i.e., the negative of the expected change in shares outstanding, - ΔS) which is -0.5%. Therefore: Income return = D/P - ΔS = 4.0 - 0.5 = 3.5%
If the company BUYS back shares it will lower the required return on the stock (hence the negative value for this coefficient in the model). If they ISSUE more shares then the investor will require a higher return on the stock.
^ that’s also wrong. If they issue more shares --> repurchase yield negative --> dilution --> lower expected return. Grinold-Kroner is a expected return model, not required return model. In the exam they’ll either give us the repurchase yield (easy because they’ll give the sign, just add it to the equation), or the %change in shares. If the %change in shares is negative (say -3%), then we add 3%. if the %change is positive (3%), we subtract 3%.
Even though this thing is pretty much take care of, you could apply a bit of corporate finance here to understand better. If % of shares outstanding next year is gonna fall by say 2%, it means there is buyback which is similar to a dividend and adds value fo investors. In turn leading to a higher return for investors. If shares outstanding increase, the company duping its overvalued shares on to investors and would not add much value and hence lower returns.
Yes, but don’t get mixed up when you see the formula, which is: Dividend Yield - share repurchase yield
So when you say positive repurchase yield, yes this does increase the return (and added to the dividend yield) but if you simply plug in the number into the equation above you’ll be subtracting the repurchase yield from the dividend yield.
So it comes down to how they phrase the question: “Reduction in shares outstanding = 4%” is the same thing as saying “repurchase yield = 4%”.
Bottom line: When # of shares is decreasing or the repurchase yield is positive you add this number to the dividend yield. Vice versa for increasing number of shares.