How Stocks Have Returned 10% Per Year

An NPR listener sent the following note after hearing my interview with Madeleine Brand this afternoon:

Mr. Blodget,

I heard your comments today on NPR’s Day to Day.  You commented that
 the broad stock market return has averaged 10% a year, long term.  I
 looked back to 1950, the earliest data I could find for the S&P which was
 17.29 back then.  If it had gone up 10% a year since that time, the S &
 P would be over 4000 today.  Yesterday’s S&P close was 816. I suggest
 that you recalculate and give the listener’s the correct correct number
 or substantiate your claim.

Did I screw up?

No, thankfully.  It’s just that the 10% number includes dividends, which is the way people normally look at stock market returns.  On a pure price basis, returns have been far lower.

In fact, here’s an approximate breakdown of the 10% average return for the last 80 years:

4 points:   Dividends
2 points:   Real EPS growth
3 points:   Inflation (reflected in EPS growth)
1 point:    Multiple expansion

Now that stocks have finally dropped back to fair value again, I thinkt the long-term return from here is likely to be in the average range again. The multiple expansion might not continue, and dividends are currently about 3%, not 4%, so it could be lower.  But the dividend payout ratio could rise again, and it may be that structural changes (more cash-efficient services companies vs. low-return-on-capital industrial companies) will lead to continued PE expansion.