What Matters More for Emerging Markets Investors: Economic Growth or EPS Growth?

Investors often allocate to emerging market equities with the expectation that higher rates of gross domestic product (GDP) growth typical of developing economies will translate to better stock market returns. Adherents to this conventional wisdom have historically been disappointed, as numerous studies of emerging and developed markets have shown GDP growth to be unreliable in predicting country-level stock returns. Using data from 15 emerging and 21 developed equity markets over samples ranging from 32 to 120 years, we confirm the failure of GDP growth as a cross-sectional predictor. What truly matters to investors is not an overall increase in economic output but rather the growth in listed companies' earnings per share (EPS) and dividends per share (DPS), which ultimately flows to shareholders. The authors confirm that, unlike changes in GDP, growth in EPS and DPS exhibit a strong positive correlation with country-level equity returns, offering emerging market investors a more effective tool for thinking about allocation decisions. Surprisingly, they also find that most emerging economies, despite their high GDP growth rate, have low EPS and DPS growth rates, suggesting that listed companies are not representative of the underlying economy.