When the Good Times No Longer Roll What Happens If Future Returns Are Lower?

REMEMBER THE UNFAILING principle described in
Chapter 2: in the long run it is the reality of business—the
dividend yields and earnings growth of corporations—that
drives the returns generated by the stock market. However, I must warn you that during the past 25 years—the
period examined in the three preceding chapters—the
12.5 percent nominal annual return provided by the U.S.
stock market included a speculative return of nearly 3
percent per year, far above the business reality.
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Recall that the century-plus nominal investment return earned by stocks was 9.5 percent, consisting of an
average dividend yield of 4.5 percent and average annual
earnings growth of 5.0 percent. A mere 0.1 percent per
year—what I described as speculative return—was added
by the rise in the price/earnings ratio from 15 times at the
beginning of the period to 18 times at its end, bringing
the total annual return to 9.6 percent.*
Paradoxically, the investment return earned by stocks
over the past 25 years was hardly extraordinary. A dividend
yield averaging 3.4 percent plus annual earnings growth of
6.4 percent brought it to 9.8 percent, almost precisely
equal to the historical norm of 9.5 percent. But, illustrating the difficulty of forecasting changes in the amount that
investors are willing to pay for each dollar of corporate
earnings, the speculative return was anything but normal.