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Stingy Investor Tip Sheet

Bear Market Snapshots

Robert Shiller recently updated his S&P500 data to include prices for the month of February. With the new data, and a little update of my own to include today's closing price, I had fun creating a slew of keen graphs.

Inflation Adjustment Leads to the 1960s

The fist one updates my graph of the S&P500's inflation-adjusted price index which doesn't include dividend reinvestment. You might remember it from my previous Party like it's 1968 article.

(click for larger version)

The blue line shows the S&P500's inflation-adjusted price level. The green line highlights its current level. The red line shows how far it would have to fall to match the 1929-1932 decline from its recent high*. The yellow line highlights the 1968 high based on daily data.

We got very close to the 1968 high today on an inflation-adjusted basis and, we'd hit it if the S&P500 fell to 656.13. (That's slightly different than the number I reported last time due to new inflation data.) The S&P500's low today came in a 666.79 which is only about 10 points more than the 1968 high.

I admit to being overly fascinated by this graph. The notion that you could buy the S&P500 for very nearly its price in 1968 is a bit of a stunner.

Party Like It's 1966!

But forget about 1968, if you look instead at the narrower Dow Jones Industrial Average then we're already at 1966 levels on an inflation-adjusted basis. The following graph shows monthly data for the DJIA, not including dividend reinvestment. But if you look at daily highs, the DJIA is well below early 1966 levels.

(click for larger version)

Folding in Taxes

The next two S&P500 graphs are tricky to explain. The graphs show inflation-adjusted returns, not including dividend reinvestment. But the return shown for a particular date is that from the date selected to today. The real return from 1890 to today is about 350% which is why the graph starts out, on the left side, at about 350%.

There are two lines on these graphs. The light purple line shows the S&P500 inflation-adjusted return without dividend reinvestment. The dark blue line also imposes a one-time capital gains tax of 20%. The graph reflects returns for an investor buying the S&P500 at a particular date, holding on, and selling at today's close when the tax is charged.

I show two versions of the graph to better highlight the full period and more recent times. You can see that if you include a 20% one-time capital gains tax, then we're already at 1960s prices. That is, if an investor bought a no-fee index fund in the late-1960s which perfectly tracked the index, spent all of the dividends along the way, and paid a 20% capital gains tax then their stake would be worth less today, on an after-inflation after-tax basis, than when they started.

(click for larger version)

(click for larger version)


The previous graphs do not include dividend reinvestment. So, it's a good idea to take a look at historical dividend yields. The following graph shows the S&P500's dividend yield as a blue line and its median yield as a green line.

You can see that the S&P500 paid a yield of about 3% in the late-1960s. While reinvested dividends have a nice way of compounding over time, and there has been a little real dividend growth since then (about 57% in total), the cash flow for the 1960s index investor hasn't been extraordinary.

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The following graph is similar to the very first one but it also includes reinvested dividends.

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As you can see, reinvesting dividends makes a huge difference over the long term. Indeed, from 1900 to 2008 U.S. stocks provided average annual real returns of 6.0% including reinvested dividends. However, without the dividends, U.S. stocks gained only 1.7% a year over the same period.

The moral of the story? Dividends are a very important source of returns for investors.

The P/E10 Ratio

The next few graphs look at the S&P500's price-to-earnings ratio. But they don't show the regular price-to-earnings ratio which is based on the last four quarters worth of earnings. Instead they are based on price divided by trailing ten-year earnings. The idea, which is generally attributed to Benjamin Graham, is to average many year's worth of earnings to get a better idea of average earnings over a whole market cycle.

The following graph shows the S&P500's price-to-ten-year-earnings ratio (P/E10). The ratio is highlighted in blue and its current level is shown in red while its median level is shown in green.

(click for larger version)

You can see that we're now well below the S&P500's median P/E10 ratio which indicates that stocks are currently a better bargain than they have been in years.

Returns vs. P/E10

The next few graphs show P/E10 versus subsequent nominal total returns which include dividends. For instance, at the start of 1991 the S&P500's P/E10 was 17.65 and its return from 1991 to 2001 was 405%. That combo appears as a point on the graph at a P/E10 of 17.65 and a total return of 405%. Each graph also shows the zero return line in green and the current P/E10 ratio in red.

There are three graphs in this series with subsequent 1, 5, and 10 year returns shown. I've plotted a point for each month between 1881 and the most recent date available. For instance, the 10-year graph's last data point is from 10 years ago because returns are measured from then to today.

The one-year graph shows a great deal of noise, or randomness, whereas the ten-year graph has a little more structure. The ten-year graph highlights the finding that subsequent returns are large when the P/E10 ratio is low. I also think it should give more than a little hope to long-term investors.

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(click for larger version)

(click for larger version)

Long-Term Returns vs. P/E10

For long-term investors, the next two graphs show P/E10 versus annualized returns over the following 20 years. One highlights nominal returns and the second real (or inflation-adjusted) returns.

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(click for larger version)

Long-Term Returns vs. Dividend Yield

All of this talk about P/E10 ratios is great but how do things look if you use dividend yield as your metric? The next two graphs show the S&P500's dividend yield versus annualized returns over the following 20 years. One highlights nominal returns and the second shows inflation-adjusted returns.

(click for larger version)

(click for larger version)


When it came to earnings I highlighted P/E10 ratios which use the average of the last 10 years worth of earnings. But the same thing can be done with dividend yields. Yield10 is calculated by taking the average of the last 10 years worth of real dividends divided by the current real price. The history of yield10 is shown in the following graph.

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The long-term yield vs. return graphs can now be reformulated using the new yield10 figures which is done below.

(click for larger version)

(click for larger version)


The '1966' DJIA, 20-year return vs. P/E10, 20-year return vs. yield, and yield10 info was added on 3/7/2009.

* I corrected the red line in the first graph to reflect a repeat of the inflation-adjusted decline in the 1929-32 period of 80.61%. It had shown a decline of 86.1%. The extra 0 was lost in transcription.

03/06/2009   11:30 PM EST   Permlink   save & shareMarkets

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