The US stock market measured by the broad-based Russell 3000 average has recently reached new highs.

But some researchers believe that forward-looking equity returns are bleak because corporate profits are at a cyclical peak and that projected earnings growth is too low.

Yet I believe the opposite is true and that US stocks are now very attractive for investors.

It is true that corporate profits, as a percentage of GDP, are at a multi-year high but, at the same time, the share of non-corporate profits to GDP has fallen.

This is because of the transformation of private and partnership capital to corporate capital. In fact, the share of after-tax corporate profits plus non-corporate profits in GDP is only slightly above the post-second world war average and well below the levels in the 1950s, so there is no need for the corporate share to fall.

Bears also claim that the current 2 per cent dividend yield is insufficient to generate good returns.

Since the long-term real growth of per share earnings is also only about 2 per cent, pessimists project real returns of only 4 per cent in the stock market, well below the 6.5 to 7 per cent average real returns that the historical data have indicated.

But earnings per share have been growing more rapidly than their historical average not only because of cyclical profit growth but also because the low dividend pay-out ratio.

This has enabled firms to issue less shares to finance expansion and has led to record share buy-backs. In essence, firms are trading dividend yield for earnings growth and capital gains.

Real returns can be estimated from the earnings yield, the reciprocal of the more popular price-earnings ratio.

Since stock earnings are based on real assets, the earnings yield provides a good estimate of the real return on the stock market.

In the US, the long-term average p/e ratio has been 14.4 times, which corresponds to a 6.9 per cent earnings yield. This is extremely close to the historical average real return on equities.

2007 estimates for earnings on the S&P 500 Index range from $87 to $91 per share. With the index at 1,450, this leads to a current p/e ratio of between 15.5 and 16.5 times and a corresponding earnings yield – and hence real return – of 6.0 to 6.5 per cent on S&P 500 stocks.

This return means that future real per share earnings can grow at 4 to 4.5 per cent per year in the long run.

Even though current returns on stocks look good, future stock returns may even be higher.

There are two factors that argue for higher long-term p/e ratios: the steep drop in transactions costs, which has allowed low-cost global diversification, and the reduction in economic volatility, which should reduce the equity risk premium.

The reduction in transactions costs and bid-ask spreads has enabled investors to acquire and maintain a fully diversified global portfolio at a small fraction required before the deregulation of brokerage costs that prevailed 25 years ago.

In addition, the decline in the variability of real economic variables in the post-second world war economy should also lead to higher valuations. Economists call the reduced volatility “the Great Moderation” and have attributed it to better central bank policy and inventory control, and a growing service sector, which is inherently more stable than manufacturing.

These factors could boost the normal p/e ratio for equities to 20, with a resulting earnings yield of 5 per cent.

From that higher level, a 5 per cent real return on stocks still yields a 3 per cent premium over inflation-indexed bonds, a margin that many money managers believe is reasonable for stocks.

If these new higher valuations come to pass, then equities will on average be priced about 25 per cent above their current levels. Even if they do not reach this higher valuation, today’s investors are holding stocks priced to yield a 6 to 6.5 per cent real return, much higher than bonds or even real estate. In summary, the valuation story today is very persuasive for equity.

Jeremy Siegel is a professor of finance at the Wharton School and a senior investment strategy adviser to WisdomTree Investments