High rates of growth in capital investment are associated with high rates of growth in the economy. However, these high growth rates are not necessarily linked to favorable equity returns. This may be the case because growth rates are already factored into equity prices. An additional explanation is that the source of equity returns is related to the rate of return on capital. If the rate of growth of capital is faster than the rate of economic growth, return on capital may decrease and equity returns may become less attractive.
My layman’s understanding: More capital investment does not mean more ROE (although GDP might increase).
Think China, massive investments in ghost towns no one lives in. GDP growth at about 6-7% is achieved by pumping in capital at 20-30% growth rate. This is not efficient use of capital. Hence high investment but low ROE
breakdown the sentences
1 Coubb douglas function investment~economy growth
2 equity price is the market view and forecast of future, say revenue, net profit, roe, p/e, all are based on a forecast on future, if the market is price in the growth, the price already factored in the growth, you can lose money when it turns out the future doesn’t in line with your expectation. Beat the expectation or fail in the expectation, the return get divergent from here.
3 If too much capital chase limited projects, marginally, it will get more difficult to maintain high return. From macro perspective, the return of capital deepening is marginal diminish.