e., of investors with
sufficient liquidity. Such expectations are influenced by the price
level - it is more difficult to find buyers at higher prices - by the
general market sentiment, and by externalities and new information,
including new information about earnings.
The capital gain anticipated by a rational investor takes into
consideration both the expected discounted earnings of the firm and
market volatility - the latter being a measure of the expected
distribution of willing and able buyers at any given price. Still, if
earnings are retained and not transmitted to the investor as dividends
- why should they affect the price of the share, i.e., why should they
alter the capital gain?
Earnings serve merely as a yardstick, a calibrator, a benchmark figure.
Capital gains are, by definition, an increase in the market price of a
security. Such an increase is more often than not correlated with the
future stream of income to the firm - though not necessarily to the
shareholder. Correlation does not always imply causation. Stronger
earnings may not be the cause of the increase in the share price and
the resulting capital gain. But whatever the relationship, there is no
doubt that earnings are a good proxy to capital gains.
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