Conventional wisdom often ignores the fundamental factors that drive the market. In this model, we will attempt to analyze the market based on simply three variables:

earning growth
dividend yield
change in the price-earnings (P/E) ratio

Our belief is that as mysterious as the stock market seems, its returns may be determined by just two simple returns; fundamental return and speculative return.

Add them together and you have the stock market total return.

Investment Return = Fundamental Return + Speculative Return - (1)

The first term, Fundamental Return, is determined by adding Earning Growth and Dividend Yield.

Fundamental Return = Earning Growth + Dividend Yield - (2)

The second term is Speculative Return, which is how much investors are willing to pay for each dollar of earnings. This is known as price-earning (P/E) multiple.

Speculative Return = Change in P/E - (3)

Fundamental return is almost predictable and a positive factor. Speculative return, on the other hand, reflected in the change of price-earning ratio (P/E), is unpredictable. Fundamental return does not change day to day, however speculative return can significantly influence day to day market noise.

Thus the Stock Total Market Return can be simply expressed as:

Investment Return = Earning Growth (ΔE) + Dividend Yield + Change in P/E (ΔP/E)

In general, a growth investor focuses on the first component, an income investor on the second, and a value investor on the third.