Total stock market return

The total stock market return is the sum of dividend yield and price appreciation. From DDM, we expect the total return to be yield plus dividend growth rate. Historically, the average dividend growth rate has been approximately 5% and the average yield has been 4.5% giving a total return of 9.5% annually. This estimate from DDM can be tested against the historical data shown in Figure 1 where the total stock market return with dividends reinvested has been plotted (blue line). As a reference, the plot also includes the return from price appreciation alone.

: Total stock market return with dividends reinvested (blue line) and with dividends excluded (green line)

Figure 1: Total stock market return with dividends reinvested (blue line) and with dividends excluded (green line). In the plot, the starting balance is $100.

 

As Figure 1 shows, the total stock market return of 9.9% annually slightly exceeds the 9.5% estimated from DDM. This is due to current high valuation of the stock market as exhibited by the historically low yield. However, the agreement over the last 100 years with the DDM is remarkably good.

For a reference, the inflation adjusted return is plotted in Figure 2. Adjusted for inflation, the total return with dividends reinvested is around 6.6% annually; however, the stock market also has had long periods (10+ years) of flat or even negative total return. This means that investors should not bank on price appreciation but should focus on dividends that do not fluctuate with speculative trading.

Inflation adjusted total stock market return with dividends reinvested (blue line) and with dividends excluded (green line).
Figure 2: Inflation adjusted total stock market return with dividends reinvested (blue line) and with dividends excluded (green line). In the plot, the starting balance is $100.

The past return does not guarantee future returns. Due to the current low dividend yield, we cannot expect the future inflation adjusted return to be as high as in the past: based on the DDM, the investors can expect to get obtain long term total return of around 7% (4% inflation adjusted) which is well below the historical return of 9.9% (6.6% inflation adjusted). Again, this is due to current high valuation that is not supported by the earnings or dividend growth.

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