Chapter NineWhen the Good Times No Longer Roll

It’s Wise to Plan on Lower Future Returns in the Stock and Bond Markets.

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. Paradoxically, however, if we simply consider only the 43 years since I founded Vanguard on September 24, 1974, the returns provided by the stock market exceeded the returns earned by businesses by among the highest margins in any period of such length in the entire history of the U.S. market.

Specifically, the dividend yields and earnings growth of the public corporations that compose the Standard & Poor’s 500 Index created an investment return of but 8.8 percent during that period (dividend yield 3.3 percent, earnings growth 5.5 percent), yet the total annual return was 11.7 percent. (See Exhibit 9.1.)

Fully 2.9 percentage points of the market’s return—fully 25 percent of the total—were accounted for by speculative return. That return reflected an upward revaluation of stocks by investors, as the price/earnings multiple more than tripled, from 7.5 times earnings to 23.7 times. (The average decade-long contribution of speculative return to the market’s total annual return since 1900 has been but 0.5 percentage points, only about one-fifth of the bounty that we investors have enjoyed since 1974.)

EXHIBIT 9.1 Cumulative Investment Return and ...

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