Stock Prices, Earnings, and Expected Dividends

An analysis indicates that data on accounting earnings, when averaged over many years, can help predict the present value of future dividends. This holds true even when stock prices are taken into account. The analysis uses the real Standard and Poor Composite Index and associated dividend and earnings series 1871-1987. The imprecise nature of earnings data means many studies of financial time series avoid using them. The present study measures earnings, either annually or as an average over several years, as an information variable in a vector-autoregressive (VAR) framework. The estimation procedure allows earnings to enter the model only if they are useful for forecasting, thus eliminating any errors in measurement. The analysis shows that the VAR forecast of the present value of future dividends is, for each year, roughly a weighted average of moving-average earnings and current real price.