Keeping the Downturn in Perspective – The Stock Market

I’d like to pass on a “back-of-the-envelope” calculation performed by Mark Coffelt of Empiric Advisors, a fellow NAPFA member:Keeping the Downturn in Perspective

Ten years ago, the S&P 500 yielded about 1.4 percent. The price-to-earnings ratio was close to 28 times. Earnings over the decades have grown about 6 percent per year. To calculate the expected return 10 years ago, we would take the dividend (1.4 percent) plus the earnings growth (6 percent) plus the change in valuations. Given that stocks historically sell at 18 times earnings on average, a change in valuations from 28x to 18x implied an expected loss over the decade of 36 percent in valuation, or about 3.6 percent loss per year. In total, a reasonable expected return would have been about 3.8 percent per year (1.4 percent yield + 6 percent earnings growth – 3.6 percent valuation change). Since the decade ended with valuations at only 12x earnings, investors didn’t even make the low expected 3.8 percent return. Rather, they lost about 1 percent per year.

What about the decade ahead? The dividend yield is currently 3.3 percent. Let’s assume the same historical 6 percent earnings growth. With the price-to-earnings at 12x, the market is selling below normal valuations – a 33 percent discount. Using the same process, the decade beginning 2009 should provide reasonably good returns of roughly 14.3 percent per year (3.3 percent yield + 6 percent earnings growth +5 percent in valuation change).

Does 14.3 percent annualized return sound okay with everyone?

About the author

Lon Jefferies, CFP®, MBA
Lon Jefferies, CFP®, MBA

Lon Jefferies is an investment advisor representative with Net Worth Advisory Group, a fee-only financial planning firm in Salt Lake City, Utah. He is a Certified Financial Planner (CFP®) and a member of the National Association of Personal Financial Advisors (NAPFA). He possesses an MBA and bachelor's degrees in Finance and Marketing from the University of Utah. Lon writes articles for local magazines such as Utah CEO, Business Connect and Utah Business Magazine, and he consistently contributes articles to online magazines such as FIGuide.com and FILife.com (by The Wall Street Journal). Additionally, Lon is an expert author at EzineArticles.com. Lon has been quoted nationally in publications such as the NY Times and Investment News.

Lon can be contacted at (801) 566-0740 or lon@networthadvice.com. Learn more about Net Worth Advisory Group at http://networthadvice.com and visit Lon's blog at http://www.utahfinancialadvisor.blogspot.com.

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