Thursday, June 26, 2014

The Real Rate of Return of Stocks

Follow young Cappy on this financial and intellectual endeavor and learn something you just aren't going to find in the MSM.

Understand that there is no such thing as capital gains when it comes to stocks.

Yes, I know there IS such a thing and that it is proven everyday day, but theoretically there shouldn't be any capital gains, let alone an entire retirement industry based on capital gains because, in theory, a market would be efficient enough to price all future profits into the current day price of a stock leaving no room for capital gains.

So why would you own a stock?

Dividends, my good boy.  Dividends.

The reason why is that dividends are THE ONLY THING THAT IS PRODUCED BY A CORPORATION THAT IS ACTUALLY PAID OUT TO ITS SHAREHOLDERS.  And this is a very important reality to understand if you wish to understand the value of stocks, because when you buy a stock you aren't

"buying the right to vote"


"purchasing a percentage of the firm's assets"

you're not even getting

"a percentage of the firm's profits."

No, you get a proportional percentage of the dividends that are paid out, if any.

That's it.  That's all a stock is.  A right to a proportional percentage of future dividends the company may pay out.

Ergo, it is ONLY dividends that matter and drive the value of a stock.

So how do stock prices stack up against the dividends they pay?  What kind of percent rate of return can you expect from dividends?  Well historically you could expect a rate of return around 5%.  But with retirement dollars and QE money flooding the market, stocks have been driven so high without a commensurate increase in dividends that you get

are you ready for it?

a WHOPPING 2% rate of return!

But are you really even getting that?

I was listening to the Kerry Lutz show and he had Danielle Park on who made the very astute point of "what about inflation?"

Indeed what about inflation and so with my SAEG I went and calculated the dividend yield going back to 1914 and adjusted it for inflation.  And shucks howdy, look at that!

Stocks really haven't been providing a positive rate of return since about the mid 70's.

A couple points, however.

One, the negative rates of return from 1974 on are obviously caused by the oil embargoes and inflationary days of the late 70's.  However, ever since then, rates have more or less remained marginally negative, stocks never really beating out inflation.  It behooves the question why are stocks going up at in real terms since their ONLY driver of value (dividends) is effectively providing negative rates of return?

Two, the retirement bubble got it's official kick off in 1978 when we had our first ordained retirement plan (the 401k).  Since then the stock market has been flooded with dollars which may have driven up capital gains (and made everybody happy on paper), but driven the real rate of return on dividends below zero.

Three, despite the dramatic increase in the stock market since 2008, you'd think inflation-adjusted dividend yields would be driven into negative territory.  However, oddly enough, they're positive in the fraction of a percentage point range.


Inflation is very low...or so we're told.

The question is if you believe the official CPI numbers being churned out.

The larger point is not one of whether inflation is being manipulated or retirement dollars are flooding the market or QE-X is driving prices higher, but yields lower.  It's just what a lousy investment stocks have been post - WWII when you look at the only thing they produce - dividends.

We don't get excited about bonds that only pay 3%
We whine about our savings accounts and CD's only paying 1%

But by god and shucks howdy, we'll plow trillions into a stock market that pays -.5% gains.

I just hope when Economics 101 classes are taught in the future, right along side the "Holland Tulip Bubble" some kind econ prof will cite this post.

Enjoy the decline.


Anonymous said...

Yes, but dividend growth is 5.43%, which probably does in fact squeak past inflation in the long run. You can invest for a negative real dividend today that becomes a decent little investment in a couple decades.

Some companies with lousy dividends historically make up for it with really great dividend growth. IBM immediately comes to mind. Utilities are the opposite.

Anonymous said...

Captain-I agree on dividends. What are your thoughts on "Dividend Reinvestment"-ie-when I get my dividend in a company-my brokerage company takes those $10(or whatever) and buys new shares with no cost. The share numbers really start to add up over time.

H man said...

It's what I always hated about the stock market. I'd rather not sell my wealth in order to profit from it. But some bald headed loud mouth will always outbid a dividend investor for the captial gains which are a faster way to profit than dividends even though it is gambling rather than investing.

Kristophr said...

Gold and silver have been blowing stocks away for returns.

In 1980, it took 43 ounces of gold to buy the DJI stocks.

Back in April, you needed 13.5 ounces.

Right now it takes 12.7 ounces.

Figure it out.

Dangerdad said...

So would it make sense that the only reason to participate in a 401k is for employer matching? Just set aside the max amount your company matches?

It seems like that's essentially optional salary, or a one-time 100% return. Unless of course TSHTF down before you can pull the money.

Orphan said...

Are the dividends in the chart being calculated for the cost at the time of purchase, or the cost of the stock at the time the dividend is issued?

I can't really imagine how the former would be reasonably done.

If the latter, inflation will be carrying the stock value up with it, meaning correcting for inflation is invalid (since the dividend, as a percentage of stock value, must necessarily rise with stock value to stay the same).

Hans said...

There is one thing you forgot, that explains part of it : increases in the dividend. Most companies increase their dividend over time, providing longterm investors with increasing returns. If that is enough to motivate current levels......probably nt.

Joe Richards said...

Hey Cappy

Love your blog, but am going to have to give you a D- on this one.

Someone else already touched on this, but dividend growth ultimately drives price and capitaly gains.

Take XOM as an example. In 2004 the dividend was $1.06 per share and share prices ranged between 40 and 52. That's 2.3% return. Today it's running between 85 and 100 with $2.46 per share (2.6%) So you've gotten 2% dividend return and about a 7% capital gains return on top. (doubled in 10 years) total return 9%. You have to be price conscious and research when you buy, and some bets pay off as negative returns, but you can make money in the market.

If you don't like to buy and sell stocks yourself. T. Rowe Price has a great fund called "Capital Appreciation" which seems to average 7% in the ten years I've had it.

Anonymous said...

Capital gains also come from the fact that a successful company will grow over time. Buy microsoft shares when its a start up and thirty years later it's a gargantuan world wide dominant business in its field.

FSK said...

Buying a stock to sell for capital gains is almost a ponzi. You're betting on some greater fool willing to buy it from you at a higher price (see LinkedIn, Facebook, Twitter, etc., where the price isn't justified by the earnings).

Of course, a zero dividend stock could theoretically pay out a dividend later. Microsoft had no dividend for a long time. Using Warren Buffet's valuation methodology, Berkshire Hawthaway stock should be worth zero if it never pays a dividend.

However, the dividends are worth it, even for 2%, PROVIDED THE DIVIDENDS GO UP FASTER THAN INFLATION. However, over the past 10-15 years, if you measure "inflation" as "price of gold" (the only fair way to do it, the CPI is nonsense), then stocks are not worth it, because dividends and earnings go up slower then REAL inflation.

The reason stocks go up slower than real inflation is that, even though you get a dividend, the CEO gives himself and his buddies options on the stock, diluting his ownership. The CEO gives his idiot friends high priced consulting contracts for doing nothing. You get the earnings, but when you deduct the waste, fraud, and abuse, you don't have a net positive return.

Marty said...

In theory, capital gains are priced into the value of a stock (Like the Captain said), and only tail-events change the value of the company over time; this makes investing for capital gains a gambling endeavor, not investment.

However, the stock itself is a hedge against inflation. A hundred dollar stock, with ten percent inflation, will be worth (or should be) 110 dollars at the end of the year. Since the stock is a piece of the company, and the company is a bunch of assets that increase in price with inflation, you're therefore covered against inflation with the stock.

This has the added benefit of making inflation less of a factor when calculating returns on dividends. If the stock covers the inflation, any dividend is automatically a gain above and beyond inflation.

Grey Enlightenment said...

yeah..this is not one of your better posts. Someone better phone Berkshire Hathaway's major shareholders and tell them that their stock is worthless because it paid a dividend only once in its 50+ years of existence. We got to spread the word that people are holding on billions of dollars of worthless stock because it never paid a dividend..

Anonymous said... are you telling me that my gains from dollar cost averaging into the sp500 for the past 20 years do not exist?

Captain Capitalism said...

Hey Grey,
It's actually one of my best posts because I got the fucking data right there.

It's a god damned mega black swan looking people right in the face.

But hey, go invest for a "real rate of return" adjusted for inflation all you want. I'm not stopping you.


Kristophr said...

They continue to believe the stock market mantra. Even smart people like Dave Ramsey are suckered.

DJI performance in dollars is only how an idiot measures it. Or a Keynesian who thinks hyperinflation is some kind of public good.

I'll repeat for the retards:
DJI 1980: 43 oz Au
DJI 2014: 12.7 oz Au

You just can't pound sense into these idiots ... They are like the elevator operator giving JP Morgan stock tips the day before the 1929 crash.

Anonymous said...

A buddy of mine picks his shares based on when they pay their dividend. He has shares in over two dozen companies and has it timed so he gets at least two dividend payments a month.
His philosophy is that if any of the companies fail he will at least have been paid some money. He also chooses for maximum dividend, so if a company drops off dividend, he finds a different on.
BTW, he's unmarried, doesn't want to get married and last year was the first year he earned more in dividends than he did in his salary.

Nils said...

I think it's also important to realize that in a strict sense what you're doing in the stock market is never investing. It's a secondary market, the investing has happened long ago, you're just buying someone else's shares.

The word investing is mostly used to obfuscate what the stock market actually is, and it sounds a lot better than the alternatives. It's speculation - then again so are most things in life.

Of course it's funny that people readily recommend gold and silver which has little intrinsic value, no dividends and call it more prudent than stock trading for capital gains.

It's all speculation people. The moment you understand that, you'll be able to make far more rational decisions.