15-Year Stock Returns Starting at Recent Valuations

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JWR1945
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15-Year Stock Returns Starting at Recent Valuations

Post by JWR1945 »

15-Year Stock Returns Starting at Recent Valuations

These 15-Year Returns complement the 30-Year Returns that I posted previously.

I have calculated 15-Year annualized real returns for portfolios containing 80%, 50% and 20% stocks when all dividends are reinvested. Expenses were set at 0.00%. All portfolios were rebalanced annually.

I examined portfolios with commercial paper as the non-stock component and with 2.2% TIPS as the non-stock component.

I have used Excel's plotting capability to fit straight lines of returns based on the data in 1923-1987 versus the percentage earnings yield 100E10/P. I have had Excel present the formulas of these lines along with the values of R-squared. I have estimated confidence limits visually.

I have calculated the results when P/E10 equals 27.0. This is close to recent levels. Looking at the latest update of Professor Robert Shiller's data, the S&P500 index in January 2004 was 1132.52 and P/E10 was 27.65. In June 2004, the S&P500 index was 1131.4 and P/E10 was 26.40. [Earnings have been increasing recently.]

Here are the results.

80% stocks and 20% commercial paper:
return = [111.52 / (P/E10)] - 2.5926
R-squared was 0.6053.
Confidence limits equal plus and minus 3.0% (using an eyeball estimate).
At today's valuations (with P/E10 close to 27), the 15-year annualized real return is estimated to be between (1.5%) and 4.5% (and 1.5% is the most likely return).

50% stocks and 50% commercial paper:
return = [76.53 / (P/E10)] - 1.5025
R-squared was 0.5826.
Confidence limits equal plus and minus plus 3% and minus 5% (using an eyeball estimate).
At today's valuations (with P/E10 close to 27), the 15-year annualized real return is estimated to be between (3.7%) and 4.3% (and 1.3% is the most likely return).

20% stocks and 80% commercial paper:
return = [41.53 / (P/E10)] - 0.6533
R-squared was 0.2637.
Confidence limits equal plus 2% and minus 5% (using an eyeball estimate).
At today's valuations (with P/E10 close to 27), the 15-year annualized real return is estimated to be between (4.1%) and 2.9% (and 0.9% is the most likely return).

80% stocks and 20% TIPS at 2.2%:
return = [107.72 / (P/E10)] - 2.0837
R-squared was 0.5781.
Confidence limits equal plus and minus 4.0% (using an eyeball estimate).
At today's valuations (with P/E10 close to 27), the 15-year annualized real return is estimated to be between (2.1%) and 5.9% (and 1.9% is the most likely return).

50% stocks and 50% TIPS at 2.2%:
return = [67.25 / (P/E10)] - 0.2585
R-squared was 0.59.
Confidence limits equal plus and minus 2.5% (using an eyeball estimate).
At today's valuations (with P/E10 close to 27), the 15-year annualized real return is estimated to be between (0.3%) and 4.7% (and 2.2% is the most likely return).

20% stocks and 80% TIPS at 2.2%:
return = [26.93 / (P/E10)] + 1.3002
R-squared was 0.5984.
Confidence limits equal plus and minus 1.0% (using an eyeball estimate).
At today's valuations (with P/E10 close to 27), the 15-year annualized real return is estimated to be between 1.3% and 3.3% (and 2.3% is the most likely return).

With 100% stocks [and with expenses set to 0.00%]:
return = [134.92 / (P/E10)] - 3.4612
R-squared was 0.5683.
Confidence limits equal plus 4% and minus 6% (using an eyeball estimate).
At today's valuations (with P/E10 close to 27), the 15-year annualized real return is estimated to be between (4.5%) and 5.5% (and 1.5% is the most likely return).

Have fun.

John R.
unclemick
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Post by unclemick »

Wow - the numbers are pushing me more and more toward putting the thumb on the scale in the direction of Dreman (contrarian) and dividend land. I would have thought TIP's would have offered more of a lift.

??? At P/E 27 - what's the dividend quotient in all this?
Mike
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Post by Mike »

The S&P doesn't look like a very good deal at P/E 27.
JWR1945
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Post by JWR1945 »

I admit surprise with these comments about these data. Perhaps, I am too close to the numbers.

I suspect that others had not already put everything together: the high valuation of the market with P/E10 = 27 or so, the high likelihood of multiple compression and the volatility of the overall market in the medium-term as well as the short-term.

At a P/E10 of 27.0, the earnings yield [with smoothed earnings] is 3.7%. If earnings are rising in general, the most recent earnings yield will be a little bit higher. Assuming a current earnings yield (E/P) of 4% (or P/E = 25.0 even though P/E10 = 27.0) and looking at today's dividend yields for the S&P500 index, we find that today's dividend payout ratio is consistent with those of the past.

If we look at dividend yields and the long-term real growth rate of (smoothed) earnings (which is 1.5% per year), we find that the long-term real gain of the market should be around 3.0% to 3.5% before we take multiples into account. Multiple compression makes the medium-term prospects bleak.

If a solid company can produce a sustainable dividend of 3.0% these days, it is priced at or below the overall market even if it has a high payout ratio. If the dividend yield is higher and sustainable or if it is 3.0% with a payout ratio around 50% or lower, the company is selling at a bargain price (relative to the rest of the market).

Have fun.

John R.
unclemick
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Post by unclemick »

I admit to being to 'far' from the numbers - carrying a mental 'breakpoint' of 4% dividends for the last several years - which makes the shopping list very small, except for perhaps some Dreman type 'fallen angels'.

Your new runs, need to be digested, and applied to my Mergent's and reviewed in light of my understanding of Dreman. I haven't read the book, only the review posted here.

Aside - Wonder what Ben Graham would said if he had TIP's for his 50/50 defensive investor portfolio.
JWR1945
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Post by JWR1945 »

I admit to being to 'far' from the numbers - carrying a mental 'breakpoint' of 4% dividends for the last several years - which makes the shopping list very small, except for perhaps some Dreman type 'fallen angels'.
I purchased some Merck recently with a dividend yield of 5%. That is quite a premium for purchasing a fallen angel.

OTOH, Dreman quoted a professional money manager who asked him whether he knew what was down there among the value stocks. Dreman was fully aware, of course, but this kind of reaction explains why value investing has been so profitable.

Have fun.

John R.
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