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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 inflationadjusted 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 inflationadjusted price level. The
green line highlights its current level. The red line shows how far
it would have to fall to match the 19291932 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 inflationadjusted
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
inflationadjusted 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
inflationadjusted 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 inflationadjusted return without dividend reinvestment. The
dark blue line also imposes a onetime 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% onetime
capital gains tax, then we're already at 1960s prices. That is, if an
investor bought a nofee index fund in the late1960s 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 afterinflation aftertax basis, than when they started.
(click for larger version)
(click for larger version)
Dividends
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
late1960s. 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.
(click for larger version)
The following graph is similar to the very first one but it also
includes reinvested dividends.
(click for larger version)
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 pricetoearnings ratio. But
they don't show the regular pricetoearnings ratio which is based on
the last four quarters worth of earnings. Instead they are based on
price divided by trailing tenyear 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 pricetotenyearearnings
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 10year graph's
last data point is from 10 years ago because returns are measured from
then to today.
The oneyear graph shows a great deal of noise, or randomness, whereas
the tenyear graph has a little more structure. The tenyear 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
longterm investors.
(click for larger version)
(click for larger version)
(click for larger version)
LongTerm Returns vs. P/E10
For longterm 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 inflationadjusted) returns.
(click for larger version)
(click for larger version)
LongTerm 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
inflationadjusted returns.
(click for larger version)
(click for larger version)
Yield10
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.
(click for larger version)
The longterm 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)
Updates
The '1966' DJIA, 20year return vs. P/E10, 20year 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 inflationadjusted decline in the 192932 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 & share  Markets 


  
