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The price of the asset is ultimately based on what it yields
(dividend for a share, rent for land). For anybody, however, who
is not determined to hold the asset for ever the expected future
price will also be important. The full return on the asset will
therefore consist of two terms
Return = Yield + appreciation,
r = y + a.
In the simplest case if the yield, say the dividend, is constant
as a proportion of the asset price and the rate of return r is
also constant the asset price A will be
A t = R/r = ( yA t + aA t )/r where a = ( A t+1 /A t - 1 ) .
The present price depends, therefore, on the future price of the
asset. The rate of return of the share r will be higher than what
you would get from holding a bond at fixed interest because of the
greater risk involved in the investment.
What course of events can justify a continuous increase in the
price of the asset (the share) that is, a positive a ? The answer
is: The internal accumulation of retained profits in the firm
which will make it possible in future to pay dividends at a
constant rate on an increasing value of the share. We may then
regard a also as an estimate of the increase in the real earning
capacity of the firm which, if it happens to be realistic will
make it possible for the price of the share to rise continuously
without the holders being ultimately disappointed.
Now the above considerations are very abstract: They do not tell
us what happens, how the share prices are formed, they tell us
only what would have to happen if a smooth development were to
result. In reality it is important that there are two types of
holders of shares: The long term holder is strongly interested in
the dividend. For him the knowledge of the future dividends would
be quite sufficient to make a clear decision. The short term