Over 130 years, U.S. equities have consistently compounded wealth at a CAGR of 8.9% (including dividends)

Total Return From Equities =

Dividend Yield + Inflation + Real Growth in + Valuation Ascribed to Business Value Business

These values are straightforward These values require us to find their ‘proxies’

This represents the change in the market’s “perception” of the value of those businesses

Total Return From Equities =

Dividend Yield + Inflation + Real Growth in + Valuation Ascribed to Business Value Business

PROXY: Cyclically Adjusted Earnings(CAE)

PROXY: Cyclically Adjusted Price to Earnings Multiple(CAPE)

Total Return From Equities =

Dividend yield + Inflation + Real Growth in Business Value + Valuation Ascribed to Business

The 8.9% CAGR was comprised of the 4 elements of the equations as shown

DecadeTotal

ReturnDividends Inflation

CAE Growth- Real

Multiple Expansion

1881 - 1890 2.00% 5.10% -1.80% 1.30% -2.50%

1891 - 1900 8.70% 4.40% -0.40% 0.80% 3.90%

1901 - 1910 7.50% 4.60% -2.00% 5.40% -4.50%

1911 - 1920 3.30% 6.20% 8.20% 0.30% -11.50%

1921 - 1930 14.40% 5.40% -1.90% -2.10% 13.00%

1931 - 1940 1.90% 5.80% -1.40% -1.20% -1.50%

1941 - 1950 12.80% 5.90% 6.20% 3.00% -2.40%

1951 - 1960 16.30% 4.60% 1.90% 4.80% 5.00%

1961 - 1970 8.10% 3.20% 3.00% 2.90% -1.10%

1971 - 1980 8.40% 4.20% 8.40% 1.60% -5.80%

1981 - 1990 13.90% 4.10% 4.70% -0.70% 5.80%

1991 - 2000 17.50% 2.20% 2.70% 3.00% 9.60%

2001 - 2010 1.20% 1.90% 2.40% 2.20% -5.30%

2011 - 2014 5.50% 0.70% 0.90% 2.40% 1.50%

*There isn’t much to distinguish between decades with high and low total return in terms of inflation or EPS growth.

*Dividends too have made a much smaller contribution to total returns since the nineties.

High Return

Low Return

• In the long term, the two primary drivers of the multiples assigned to cash flows, namely interest rates and growth expectations, tend to revert to mean.

• So, changes in valuation’s impact on total investment return over long periods should be insignificant.

• Our view is supported by Table alongside which displays that changes in valuation was a very small contributor to total investment returns at 0.3%.

Since: Inflation + Real Growth = Nominal Growth

Hence:Long Term Total Return from Equities = Dividend Yield + Inflation + Real Growth in Business Value

Long Term Total Return from Equities = Dividend Yield + Inflation + Real Growth in Business Value

• Above equation makes it clear that capital gains of return is largely attributable to underlying business value growth.

• Using the data from Table alongside, capital appreciation (Inflation + CAE Growth= Real) contributed about 4.0% to total return from equities.

• Hence, business value growth of companies in S&P 500 has approximated to an annual average rate of 4.0% over this period.

• According to Flow of Funds report, net worth of nonfinancial corporate businesses grew at a CAGR of 7.1% between 1945 and 2014.

• We consider net worth a good proxy for business value growth.

• Over this same time frame, S&P 500’s price increased at a CAGR of 7.2%.

• Thus, Flow of Fund Accounts, also support the assertion that price returns earned approximate the underlying business value growth.

We conclude this section with the assertionthat price appreciation component of thetotal return from equities is largely composedof growth in underlying business value.

7.2% return is the geometric mean of the S&P 500 yearly returns between 1945 & 2014.

As seen, there are several observations in the negative territory.

Note: It doesn’t imply that every business included in the index grew at 7.2%.

• If price growth of a portfolio = the underlying business value growth;

• Then an investment process that successfully identifies businesses that grow their business values at aboveaverage rates over long-term should generate superior long-term investment returns.

Key is to be able to identify businesses that are to the far right of the underlying business value growth distributions and have the ability to stay in that zone.

It is important to understand that a business with “competitive advantage”should have the ability to stay in that zone, which indicates its“sustainability”.

Therefore, to enhance investment returns one must invest in businessesthat can grow their business values at above-average rates in asustainable manner.

We at Multi-Act refer to such businesses as High Quality (HQ)businesses and we further posit that High Quality is a distinctinvestment style.