A Bar Too High

For stocks to meet expectations over next 10 years, valuations must rise to highest they’ve ever been in history.

That’s quite a statement.  But it’s not my math.  The formula comes from the founder of index investing and steward of the largest buy and hold investment company in the world…John Bogle.

Some background:

Last year we penned a post on “The John Bogle Stock Valuation Model“.  An excerpt:

Here’s his equation for those that want to play around at home. He published this I believe about 25 years ago, and here is an updated white paper with more info, but it’s pretty simple.

10 year annualized stock returns = dividend yield + earnings growth + change in P/E ratio.

You can go read the old post for background, but historically that has worked out to:

9.6% = 4.2% + 4.7% + 0.3%

That gives you 9.6% returns (nice!), with dividends of 4.2%, earnings/dividend growth at 4.7%, and a slight valuation bump from valuations increasing over the period.

What about going forward?  You can plug in today’s numbers.  We’ll assume today’s dividend yield, and assume earnings the same as history, and no valuation changes.

6.7% = 2.0% + 4.7% + 0%

So already you’re down to 6.7%.  That’s not bad though.  Way better than 2% bond yields.

(Nerd note:  You can tear apart the 4.7% dividend/earnings growth into real dividend growth and inflation.  One of the effects of increased buyback since 1990s is that dividend YIELD is lower, but dividend GROWTH is higher.  So, you can argue that the 4.7% should actually be a percent or two higher.  But, inflation also isn’t 3% either, so it somewhat balances out.)

However, survey after survey show that investors are currently expecting returns of about 10.5% for the stock market.  (Survey here and here and here.)  We’re written about how delusional that is before.

So, below is a table with potential outcomes for annualized 10 year stock market returns assuming dividend/earnings growth is similar to historical #s.  The only variable becomes “What will the stock market be valued at in 2017?”

With a current CAPE ratio of 29, that means the stock market multiple needs to INCREASE to all-time 1999 bubble highs to meet investor expectations.  Now ask yourself, how likely is that? Another old post on the topic here. 

Earnings and dividend growth could also double, and valuations stay flat, but unless Elon Musk finds liquid gold at the core of Mars, that is also unlikely.




More likely are the two scenarios  boxed in the middle. Still positive, but not great.  And certainly not in line (or above!) investor expectations.  And we all know from relationships, jobs, and investing – there is nothing more damaging to the emotional psyche than having a core set of beliefs and expectations, and then having that worldview destroyed.

Sort of like this video I share in my presentations….the investor has just set the bar way too high….So maybe listen to the words of Steven Hawking…and think about resetting your expectations…

“My expectations were reduced to zero when I was 21. Everything since then has been a bonus.”

[The Science of Second-Guessing (New York Times Magazine Interview, December 12, 2004)]”
Stephen Hawking

So, lower your expectations.  Spend less, save more.  Or think about the message we’ve been preaching for years.  Place at least half your stock allocation in cheaper foreign stocks.  And for fun, go plug in our numbers into Bogle’s formula for a bucket of cheap countries with higher dividends and much, much lower valuations…

Instead of being disappointed, you just might be surprised…