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Hello,
please, could anyone explain to me why this sentence is true:
“The historic earnings growth is greater than the company’s equity cost of capital and is therefore not sustainable over the very long run”
Why is it not sustainable ? I do not see the link between company’s equity cost of capital and its earnings growth rate…
Welcome to the Opentuition forums. The implication of the above would be near infinite growth of earnings. A lot of this is because of phrase “very long run”. Of course over short term or longer, companies can and do perform better than the market expects them to perform.
It’s as if a football team kept winning matches but the odds never adjusted to appropriately reflect this fact. It wouldn’t happen because if it did bookmakers would go bust. The odds would adjust. Likewise there really should be no “free lunches” according to the capital asset pricing model. Higher returns are compensation for higher risks. I Don’t know if that helps. Please feel free to ask more questions.
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