Wednesday, December 03, 2008

How Stocks Have Returned 10% Per Year

After Henry Blodget from Clusterstock was on NPR saying that stocks were back to "fair value" (i.e. their long run average), he had a listener email him about how the 10% annual return in stocks is found. His answer is below:

How Stocks Have Returned 10% Per Year:
"...the 10% number includes dividends, which is the way people normally look at stock market returns. On a pure price basis, returns have been far lower.

In fact, here's an approximate breakdown of the 10% average return for the last 80 years:

4 points: Dividends
2 points: Real EPS growth
3 points: Inflation (reflected in EPS growth)
1 point: Multiple expansion

Now that stocks have finally dropped back to fair value again, I thinkt the long-term return from here is likely to be in the average range again. The multiple expansion might not continue, and dividends are currently about 3%, not 4%, so it could be lower. But the dividend payout ratio could rise again, and it may be that structural changes (more cash-efficient services companies vs. low-return-on-capital industrial companies) will lead to continued PE expansion"

No comments: