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The Risk Premium Factor: A New Model for Understanding the Volatile Forces that Drive Stock Prices by Stephen D. Hassett

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Chapter 6

Risk-Adjusted Real Implied Growth Rate (RIGR)

The Risk Premium Factor (RPF) Model can be used to solve for implied values of any variable based on current valuations. This analysis is useful for understanding the overall market and individual companies.

In addition to assessing the stock market's current value versus predicted, the RPF Model can be used to extract implied values for any of its variables by rearranging the equation, P = E/(Rf × (1 + RPF) − (Rf − IntR + GR)), to solve for the implied value of any variable:

Unnumbered Display Equation

Note that since the original equation is obviously not valid for earnings (E) of less than zero or for values approaching zero, none of these equations should be used where E is negative or very low.

These transformations have multiple direct uses. With confidence in one or more observed variables, the equations can be used to test hypotheses, such as solving for the implied growth rate at a given current price, then testing those results at different interest rate levels. For example, on October 10, 2010, the 30-year yield was 3.7 percent, forward earnings were $80, and the Standard & Poor's (S&P) Index was 1,163, so the implied long-term real growth rate was only 0.6 percent. Bear in mind that is not next year's growth but in perpetuity. It is hard to believe that the long-term growth rate for the S&P 500, which should parallel the overall economy, ...

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