An Alternative Estimation Method of the Equity Risk Premium using Financial Statements and Market Data

This paper develops a method to estimate the equity risk premium. The method exploits the Earn Back Period (EBP) formula presented by Luoma and Ruuhela (2001), which is a generalization of the P/E ratio. The EBP has a clear theoretical interpretation and can be used to compare stocks with different earnings growth rates, while the P/E ratio is not useful if stocks have substantially different growth rates. Since growth is taken into account, differences in EBPs are due to risk. Using this property, a stock's risk premium is derived from the stock's current P/E ratio and from its growth rate of earnings. For investors, this offers a practical method for evaluating stocks.