I've argued elsewhere that valuation is important -- it is important not to overpay for investments. A common basis for valuation is earnings; investors decide how expensive the market is based upon how much one has to pay for one dollar of earnings -- the price / earnings ratio. In this blog, I refine that a bit and look at normalized price/earnings ratios. (About Normalized P/E Ratios describes my normalization process.) However, this is not the only way to assess valuation. Another popular valuation metric is the price/dividend ratio -- how much must an investor pay for one dollar of dividends (or, conversely, what is the investor's dividend yield)?
100 Years of Stock Market Price/Dividend Ratio History
|Dow Price/Dividend Ratio History|
The above chart (click to expand) shows the 100-year history of
the Dow price/dividend ratio. For example, the first point on the graph shows that at end-of-year 1900 investors were willing to pay approximately $23 for each dollar of dividends (The end-of-year price was $70.71, and I estimate that investors received about $3 in dividends).
As you can see, for much of the last more than 100 years the price/dividend ratio cycled between 10 and 30, and averaged somewhere around 20. Readings of 30 or above were more often than not associated with periods that, in hindsight, we know were near stock market peaks -- e.g., 1928 and 1965.
What's Going On Here? Is 30 the New 10?In the last 20 years, however, the price/dividend ratio has consistently scored above 30. In 1999, the price/dividend ratio maxed out at 68.2 -- almost twice the previous high prior to 1990. The market carnage of 2000-2002 and 2007-2008 finally brought the p/d ratio down from the stratosphere. However, after dipping below 30 in 2008 the p/d closed 2010 around 40 before dropping back to 37.4 at the end of 2012. Still, unless the world has changed, unless 30 is the new 10, the price/dividend ratio seems to be sounding a warning.
100 Years of Stock Market (Dow) Dividend Yield History
|Dow Dividend Yield History|
Looked at from the dividend yield perspective, the results are equally disturbing. The above chart (click to expand) shows the 100-year history of the Dow's dividend yield. The first point on the graph shows the dividend yield at end-of-year 1900 was about 4.3% -- roughly $3 in dividends divided by a closing price of $70.71. Remember, this is exactly the inverse of the price/dividend ratio. As a result, we could also take 1 divided by the price/dividend ratio, or 1/23, and get the same 4.3%.
For much of the last 100 years, the dividend yield ranged from 3-3.5% on the low end, to 10-11% on the high end. Readings in the 3-3.5% range were historically associated with bad outcomes. However, in the last 20 years, 3-3.5% has been more like a ceiling than a floor. Since price/dividend ratios have been extraordinarily high, it follows that dividend yields have been extraordinarily low -- the lowest in history. At year-end 1999 the dividend yield reached an all time year-end closing low of 1.5%! At the end of 2012, the yield stood at 2.7%
Not a Cheap Stock Market From a Dividend Yield Point of ViewI don't mind saying this makes me a little nervous. This is clearly not good news, but may not be quite as bad as it seems. Today's investors supposedly prefer capital gains to dividends since capital gains receive a more favorable tax treatment. Partially in response, companies have reduced their emphasis on dividends substantially in the last quarter-century. However, historically the dividend contribution to long-term stock market returns has been critical. Unless the reduction in dividends is offset by higher earnings growth rates or further increases in price/dividend ratios (gasp!) long-term returns will suffer.
Note: The above chart is based on DJIA (Dow Jones Industrial Average) data from my Stock Market Analysis Model. Results would be comparable if we used S&P 500 data. Dow dividends prior to 1929 have been estimated based upon another stock market index.
Related PostsStock Market P/E Ratio History Since 1929
The Dividend Contribution to 50-Year Total Return shows the historical importance of dividends on 50-year returns.
The Dividend Contribution to 10-Year Total Return shows the historical importance of dividends on 10-year returns.
Additional posts showing the relationship between valuation and future returns:
Rolling Returns vs P/E Ratio Graphs Rolling 10 & 20 year returns showing starting p/e ratios.
The Impact of Starting P/E Ratios on 10 Year Returns
Stock Market P/E Impact on Future Returns similar to the above, but showing the dollar impact.
For lists of other popular posts see the sidebar to the left or the blog header at the top of the page.
Copyright © 2010. Last modified: 2/12/2013
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