WE’RE TOLD OVER AND
over that growth in corpo-
rate earnings drives stock
market returns. If that’s the
case, what has been going
on lately? In 2019, Standard
& Poor’s 500-stock index
posted a total return of 32%,
but corporate earnings
barely moved. In 2018, with
corporate profits solidly up,
the market surrendered
4.4%. The truth is,
earnings are only
part of the picture
when it comes to
stock market returns.
Understanding the
whole mosaic can
give you insight on
how to manage your
portfolio.
You can divide
stock returns into
three primary driv-
ers, which can work
in concert or at odds:
earnings growth,
valuation and divi-
dends. In a vacuum,
earnings growth is the easi-
est to understand. Say a
stock costs $100 per share
and posts earnings of $10
per share. If earnings grow
by 5%, to $10.50, then the
stock price should grow by a
commensurate 5%, to $105,
producing a 5% return.
But stock prices ref lect
what investors expect in
the future. Their confidence
or negativity about a stock’s
potential is expressed in itsvaluation, commonly repre-
sented by a measure such
as the price-earnings ratio.
If investors are bullish on
a stock, they’ll bid up the
price, thus “expanding” the
stock’s price-earnings mul-
tiple and boosting return.
Say the $100 stock with
$10 in earnings has a P/E
of 10. Should confident in-
vestors bid the price up to12 times earnings, the stock
would now trade at $120, a
20% return. In 2019, 29 per-
centage points of the S&P
500’s 32% return came from
valuation expansion. “Valu-
ation expansion last year
was in anticipation of earn-
ings growth this year,” says
analyst Willie Delwiche,
at investment firm Baird.
Understanding where the
market’s valuation stands
compared with historicalaverages can give investors
a sense of market risk, says
Delwiche, because valua-
tions tend to revert to mean
levels over time. At 18 times
expected year-ahead earn-
ings, the S&P 500 trades
above the 10-year average of- That doesn’t mean prices
will come down imminently,
Delwiche says, but it could
signify that investors should
explore less-volatile pockets
of the market or consider
investing overseas, where
stocks are trading closer to
historical norms.Count on dividends. Income
investors know the power
of the third major driver
of total returns: dividends.
Since 1955, earnings growth
has contributed 63% of the
S&P 500’s total annual re-
turn, on average, followedby dividend payments (28%)
and expansions or contrac-
tions in valuation (9%), ac-
cording to Calamos Wealth
Management.
Of those factors, dividends
are the least volatile and
don’t ever detract from the
market’s return. As a result,
reinvested dividends have
an outsize impact on the
market’s return over time.
From the end of
1970 through 2019,
78% of the total
return of the S&P
500 came from the
compound growth
of reinvested divi-
dends, according
to analysts at the
Hartford Funds. The
message is clear, says
CFRA investment
chief Sam Stovall:
“Dividends reward
the buy-and-hold
investor.”
What will drive
returns in 2020?
Calamos chief investment
officer Reed Murphy be-
lieves the baseline case is
for valuations to hold rela-
tively steady and for earn-
ings growth for companies
in the S&P 500 to come in
below current estimates of
9%-plus. He suggests the
S&P 500 is likely to return
7% to 8% in 2020, including
a 1.9% dividend yield. ■BUILDING BLOCKS OF TOTAL RETURNS
Adding It UpStock market returns are made up of three major components.SOURCE: Calamos Wealth ManagementWhat Drives Stock Returns?
PRACTICAL PORTFOLIO Ryan ErmeyHint: It’s more than just company profits.
YOU CAN REACH THE AUTHOR AT
[email protected].04/2020 KIPLINGER’S PERSONAL FINANCE 632010201110%–10%
–20%
–30%
–40%20%30%40%2012 2013 2014 2017 201920182015 201615.1%
2.1%16.0%32.4%13.7%
1.4%12.0%21.8%–4.4%31.5%Dividends EPS growth P/E expansionS&P 500-stock index total return0%