Spring 2019 Conference Agenda

Projections of year-to-year equity performance often rely on the Earnings Yield (EY) as a convenient proxy for the expected return. However, this estimate fails to include appropriate consideration of the firm’s growth prospects. A further (more serious) complication arises when the risk premium is calculated as the EY less some appropriate interest rate. In both these situations, an adjustment is needed that reflects the notional future earnings stream derived from prospective future high-return investments and/or growth opportunities.

Even in theory, these “franchise opportunities” may be comprised of a highly complex and uncertain structure with multiple future opportunities having various investment magnitudes, different returns, and all across a spectrum of distinct availability times. The specific form of a firm’s franchise structure will play a key role in determining the path and the relative sensitivities of the firm’s price and earnings growth (and hence of the PE’s as well). We refer to the total value of these opportunities as the firm’s Franchise Value (FV). For certain purposes, the FV itself can serve as a sufficient parameter that encompasses much of this complexity described about.

In this paper, the “Franchise Earnings” associated with the FV form the basis of a Franchise Earnings Yield (FEY), which we label g*. Since this g* term is analogous to the standard current earnings based EY, the expected return can be viewed as the sum of two yields -- the standard EY and g*. And, this g* turns out to be just the adjustment needed to bring the standard EY into appropriate alignment for estimation of the expected return and the risk premium.