Subject: Re: S&P500 valuations
1. You says sales increased by 3.8% and roughly matches inflation. So no real sales growth. The composition of the sales changed quite a bit. Grocery/department stores sales cannot be weighted the same as say iPhone, Google Ads, Amazon 2P sales, etc.

Very true. These new business models have higher profit margins, so this observation aligns with the general higher profit margin observation. However the positive trend in profit margins can reverse also, as strong moat business models with high pricing power only have finite tolerance to competition, as special each new era feels. For example, Alibaba has been purchasing low margin business over the last few years, essentially barely profitable infrastructural and other physical-economy purchases, to retain their competitive edge.

We have become accustomed to a lot of pro-business trends and part of my post was to not take that for granted as continuing to trend in the same direction, but potential heating at the current level. Even halting these trends (not reversing but retaining present policies) would result in lower EPS growth than we are accustomed to observing and may simply take for granted as normal.**

3. You say much of the value was via dividends. Now a lot more is retured via stock buybacks even after accounting for options.

The buy-backs were accounted for in this sales growth as the sales data I gave were for the per-share sales growth rather than the total sales growth.

6.5% real returns were during a period of time when there are impossible for anyone to earn those kinds of returns.

I agree that it is rational for stocks to be priced a little higher because of the lower brokerage costs (our nominal return being lower, but the after-cost return not being so bad). This still results in lower earnings yields (and lower dividend yields) than the past, because of the lower brokerage costs, so business making purchases between each other must also accept the lower returns. Think carefully about the conclusion, though. If we accept the higher prices (and lower earnings yields, and lower dividend yields) as rational both today, and into the future, then our returns will be, by mathematical observation, lower than the past 6.5% with other factors unchanged.*

Until the 1950s people thought stocks must have higher dividend yield than bonds because stocks are riskier. But they wised up as they realized that stocks dividends grow. Similarly people have realized the advantages of stocks and everyone and their dog knows that stocks are a primary building block of retirement portfolios. There is a huge industry that developed to educate, provide automatic workplace retirement plans, etc. Now I dont think people would need as much equity risk premium as in the past. Instead of 6.5% they might settle for 4%. So valuations can and should be higher than the past.

True, which complements the previous point. You are, correctly, staying that the higher prices are rational. But that does not imply that returns from here will be as good as the past, but rather it implies the opposite. With these higher valuations, we have lower earnings yields and so business will have lower returns from equity investments (either buying their own stock, or the stock of other firms, both having to be purchased at higher multiples than the distant past and so receiving less business (less earnings) for each dollar invested). Businesses also provide lower dividend yields, and both sources of investment contribute to lower returns even if these higher multiples are retained forever. If adapting these points to my previous post, it should slightly lower one's expectation for future returns further again.

- Manlobbi

* High valuations produce lower returns even if the high valuation is retained and not returned to lower level. This is because the lower yields continuously produce a lower return for each dollar invested. Let us say we live in a world in which the CAPE ratio would remain at 60 (valuations twice what they are today), and remaining at that high level forever. We could assign any argument to state that the higher price is rational. Both the dividend yields (per dollar invested) would then only return half what they formerly returned, and buybacks and other investment purchases would only receive half the amount of business per dollar invested. Conversely, if stocks were to be permanently priced at one quarter the present multiple, and they retained that level for the next 40 years, our returns would be enormously larger - we would experience a much sharper compounding effect also. The lower valuations (higher yields) in the first half of last century contrived to this 6.5% total return, which we are unlikely to enjoy into the future even if multiples do not return to a lower level at some point, but are simply retained. We can affirm that the higher multiples today are rational, but this does not escape us from the future returns being lower than the past even if these higher multiples were to be retained forever, which shouldn't be assumed also.

** Corporate taxation policy has also trended down for a few decades, and for that trend to continuing you would have to go from a very low tax to zero towards a zero or negative tax, which won't happen. Tax policy can trend upward again at some point, as it did in the past. We also have experienced a gradual reduction of regulation (especially wage conditions such as the minimum pay declining in real dollars). If the low tax policies or low regulation policies are merely retained, then expect a new tailwind for business that did not exist over the past few decades. This is not intuitive, but if conditions were in the past changing for the benefit of business, then merely having these conditions no longer changing but simply retained (time derivative moves from positive to zero) then this actually produces a business tailwind. If the conditions revert to the past (time derivative moves negative) then the tailwind is much harsher.