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Decline

26-02-2025 · Insight

Decomposing equity returns: Earnings growth versus multiple expansion

Over the past decade, the stock market has been dominated by the US economy, led by big tech and driven by strong earnings growth and multiple expansion. Companies such as Apple, Microsoft, and Nvidia have fueled this rally, pushing US equities to record weights in global indices and high valuations versus historical norms and other markets. Compared to US growth stocks, European equities, emerging markets (EM), value stocks, low-volatility stocks, and small-cap stocks appear relatively cheap. But do these alternatives present the same investment case?

Download the full paper here


Summary

  1. US equities led due to strong growth and valuation expansion

  2. Small-cap and low-volatility stocks had strong fundamentals but lacked market appreciation

  3. Emerging markets struggled with weak earnings, except for Taiwan and India

To explore this, we decompose equity returns into earnings growth and multiple expansion. This analysis highlights key differences behind underperformance. Small-cap and low volatility stocks delivered strong earnings growth but lagged due to stagnant valuations. EM equities, however, struggled due to weak earnings growth, despite rising valuations. Taiwan and India were exceptions, posting solid earnings growth, though not enough to offset poor performance from China, Korea, and EMEA.

Ultimately, small-cap and low volatility stocks suffer from a lack of investor appreciation, while EM equities need a turnaround in operating performance.

Figure 1 | Decomposition of annualized total returns 2015-2024

Figure 1 | Decomposition of annualized total returns 2015-2024

Source: MSCI, Robeco. This chart is for illustrative purposes only.

Key findings: What drove performance?

Our approach follows John Bogle’s return decomposition formula:
Return = Dividend Yield + Earnings Growth +/- Change in P/E Ratio

This framework helps distinguish between returns driven by fundamentals – dividends and earnings growth – and those influenced by valuation changes. We applied this method to MSCI country and style indices over a ten-year period (2015-2024) to analyze regional and style-based return drivers.

  • US equities outperformed
    The US market led global performance, benefiting from both the highest earnings growth and significant multiple expansion.

  • Europe & Japan: modest growth, little valuation expansion
    These regions saw lower earnings growth and little multiple expansion, leading to weaker total returns.

  • EM struggled, with some exceptions
    Despite rising valuations, EM equities suffered from weak or even negative earnings growth. Taiwan and India posted strong earnings, but underperformance in China, Korea, and EMEA weighed on the region. LatAm struggled due to multiple contraction.

  • Small-cap and low volatility stocks: strong earnings, but out of favor
    Small-cap stocks consistently delivered stronger earnings growth than large caps. Based purely on fundamental returns, European small caps led all indices. However, their stagnant valuations constrained total returns, particularly in the US. Similarly, low volatility stocks posted robust earnings growth but failed to see valuation increases.

  • Value vs. growth stocks: US growth stocks dominate
    US growth stocks outperformed, fueled by both earnings growth and multiple expansion. Even US value stocks beat growth stocks in Europe, Japan, and EM. In EM, both value and growth stocks suffered negative earnings growth, though EM growth stocks benefited more from multiple expansion, while EM value stocks gained from dividends.


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Past performance is no guarantee of future results. The value of the investments may fluctuate.

Is a turnaround in sight?

US growth stocks are still going strong. Although earnings growth dipped in 2019-2020 and valuations contracted in 2021-2022, both have since rebounded. However, EM equities have shown little sign of a sustained recovery, with earnings stuck in a cyclical but flat trend.

What does this mean for investors? History suggests that dividends and earnings growth are the main driver of long-term returns, with valuation multiples prone to mean-reverting. While US growth stocks may continue to lead, the healthy fundamentals of small-cap and low volatility stocks indicate potential future opportunities. Earnings in EM will also rebound at some point, and, if the US earnings cycle peaks, US stocks could face multiple contraction.

Rather than extrapolating past trends, investors should prepare for a shifting market environment. A well-diversified portfolio across regions, sectors, and asset classes remains essential for resilience, regardless of how the next decade unfolds.

Download the full paper here


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Important information This disclaimer applies to any documents and the verbal or written comments of any person in presentations or webinars on this website and taken together is referred to herein as the “Information”. The services to which the Information relate are NOT FOR RETAIL CLIENTS - The information contained in the Website is solely intended for professional investors, defined as investors which (1) qualify as professional clients within the meaning of the Markets in Financial Instruments Directive (MiFID), (2) have requested to be treated as professional clients within the meaning of the MiFID or (3) are authorized to receive such information under any other applicable laws and must not be relied or acted upon by any other persons. This Information does not constitute an offer to sell, or a solicitation of an offer to buy, any financial product, and may not be relied upon in connection with the purchase or sale of any financial product. You are cautioned against using this Information as the basis for making a decision to purchase any financial product. To the extent that you rely on the Information in connection with any investment decision, you do so at your own risk. The Information does not purport to be complete on any topic addressed. The Information may contain data or analysis prepared by third parties and no representation or warranty about the accuracy of such data or analysis is provided.
In all cases where historical performance is presented, please note that past performance is not a reliable indicator of future results and should not be relied upon as the basis for making an investment decision. Investors may not get back the amount originally invested. Neither Robeco Institutional Asset Management B.V. nor any of its affiliates guarantees the performance or the future returns of any investments. If the currency in which the past performance is displayed differs from the currency of the country in which you reside, then you should be aware that due to exchange rate fluctuations the performance shown may increase or decrease if converted into your local currency. Robeco Institutional Asset Management B.V. (“Robeco”) expressly prohibits any redistribution of the Information without the prior written consent of Robeco. The Information is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use is contrary to law, rule or regulation. Certain information contained in the Information includes calculations or figures that have been prepared internally and have not been audited or verified by a third party. Use of different methods for preparing, calculating or presenting information may lead to different results. Robeco Institutional Asset Management UK Limited (“RIAM UK”) is authorised and regulated by the Financial Conduct Authority. RIAM UK, 30 Fenchurch Street, Part Level 8, London EC3M 3BD (FCA Reference No:1007814). The company is registered in England and Wales under Ref No. 15362605.

In all cases where historical performance is presented, please note that past performance is not a reliable indicator of future results and should not be relied upon as the basis for making an investment decision. Investors may not get back the amount originally invested. Neither Robeco Institutional Asset Management B.V. nor any of its affiliates guarantees the performance or the future returns of any investments. If the currency in which the past performance is displayed differs from the currency of the country in which you reside, then you should be aware that due to exchange rate fluctuations the performance shown may increase or decrease if converted into your local currency. Robeco Institutional Asset Management B.V. (“Robeco”) expressly prohibits any redistribution of the Information without the prior written consent of Robeco. The Information is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use is contrary to law, rule or regulation. Certain information contained in the Information includes calculations or figures that have been prepared internally and have not been audited or verified by a third party. Use of different methods for preparing, calculating or presenting information may lead to different results. Robeco Institutional Asset Management B.V. is authorised as a manager of UCITS and AIFs by the Netherlands Authority for the Financial Markets and subject to limited regulation in the UK by the Financial Conduct Authority. Details about the extent of our regulation by the Financial Conduct Authority are available from us on request.