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I found a way of investing that makes a lot of sense to me.
An example will explain it best.

Unfortunately, the table don't show up.

We show the U.S. versus non-U.S. stock performance attribution in this table.



Now that we have compared historical returns, let's formulate some expected returns for U.S. and non-U.S. stocks.


First, let's assume earnings growth will be the same in the decade ahead as it was in the previous ten years. Let's also assume dividend yields will stay the same as they are now.


Finally, let's assume valuations for U.S. and non-U.S. stocks stay the same with a price-to-earnings (P/E) ratio of 22.0 for U.S. stocks and 14.9 for non-U.S. stocks.


Here are the expected returns for U.S. and non-U.S. stocks over the next decade using those assumptions. They are essentially the same with an expected return of over 8% annualized.



Let's take a look at another scenario. If we assume the P/E ratio of U.S. stocks falls to its long-term average of 17.7 and the P/E ratio of non-U.S. stocks rises to its long-term average of 18.5, then the expected return scenario is quite different from our first scenario.


In this scenario, non-U.S. stocks are now expected to outperform U.S. stocks by over 4% per year.


Perhaps a decade from now, U.S. stocks' price-to-earnings ratios stay the same, and non-U.S. stocks only get a little more expensive.


Even if that were the case, non-U.S. stocks would still outperform U.S. stocks.


These scenarios ignore the potential impact of currency fluctuations given how difficult it is to accurately predict currency movements. Just know that if the U.S. dollar weakens relative to other currencies, non-U.S. stock returns will be higher. If the dollar strengthens, then non-U.S. returns will be lower.

Decision Time


Based on this analysis, an investor might decide to invest more funds in non-U.S. stocks.


There is a reasonable base case for why non-U.S. stocks will do as well as or better than U.S. stocks.


Even if an investor decides not to invest more in non-U.S. stocks, this analysis could give them confidence not to sell their underperforming non-U.S. stock funds because the return over the next decade could be 8% or more annualized.


An understanding of historical and future returns makes for a more informed decision. That is the power of knowing what drives stock index returns.

Money for the restofus has a product they sell for 149.00 that gives you all the data you need to make these decisions. I am not recommending it, just telling you it exists.

First, let's assume earnings growth will be the same in the decade ahead as it was in the previous ten years...

The overall approach is a sensible top level view.
But this quote is probably the weakest assumption in that chain--net margins can vary a LOT.
They vary both shorter term with the business cycle, and over longer time frame with big changes in things like taxation and the bargaining power of labour, and import competition.
Have a look https://fred.stlouisfed.org/graph/?g=cSh
Periods of rising net margins give rising profit figures, but that dynamic can't be extrapolated.

Fortunately that's pretty easy to correct for.
Rather than using the recent profit growth rate figure to estimate future profit growth, use the recent sales growth rate figure as an estimate of future profit growth.
Of course it should be inflation adjusted to get a meaningful number.


A good thing to remember: Over the long run, profits can't rise any more than sales, because net profit margins can not rise without limit.
We know for sure that if there are normal profit-seeking companies a million years from now their profit margins will not be over 100%, nor less than zero.
It's not a simple cycle, but they have to wander forever in a firmly bounded range from 0% to 100%.
A squishier but more practical view: in the last 75 years US net corporate margins have only rarely been below 5%, and only very rarely above 11%.

The latter figure included last year, which is why I suggest it would be unwise to simply extrapolate current profitability.


FWIW, S&P 500 real sales per index point have risen inflation + 2.2%/year in the last decade and inflation+2.3%/year in the last 20 years.
So for a profit forecast figure, I would try to estimate what today's profits were if this year were neither unusually good nor unusually bad on the net margin front,
then pencil in real profit growth of around 2.2%/year from there.
This gives us a pretty darned good idea what the stocks will be worth in aggregate in future, as value ultimately comes from profits.
The big problem with this is trying to estimate what future market multiples might be for the broad market--we might know their future value but have little idea about their future prices.
The best can do is say something like "if net margins and market multiples resemble their 15 year averages, then market returns will probably be around X%/year from here, after a one-time adjustment of Y%".
But it's a big "if".


You can come up with a super simple rule of thumb, which is really dumb but actually not that bad:
Since dividends historically trend so smoothly, your rate of return buying the broad market, absent any big change in valuation multiples, will be roughly the dividend yield on purchase date plus inflation plus 2.2%/year.
The SPY yield is about 1.55% right now.

Jim

'You can come up with a super simple rule of thumb, which is really dumb but actually not that bad:
Since dividends historically trend so smoothly, your rate of return buying the broad market, absent any big change in valuation multiples, will be roughly the dividend yield on purchase date plus inflation plus 2.2%/year.
The SPY yield is about 1.55% right now.'

Should we add anything in for buybacks in lieu of dividends?

Assuming dividends would be a bit higher if buybacks weren't more tax efficient.

Perhaps in the case of a specific company which does not issue option grants adding something for buybacks could make sense.
Per cnbc, the share count of the S&P 500 in the last five years has gone up slightly despite record buybacks. On average, buybacks just offset option grants.
JK

Should we add anything in for buybacks in lieu of dividends?

Not really.
The 2.2%/year figure is from recent decades when buybacks have been high on average, so that's probably baked in, if it's needed.
The "normal" historical rate of growth of profits was usually more like inflation + 1.7%/year, prior to that.
There are several factors going into the recent upswing in profitability, potentially including buybacks.

Personally I suspect the buybacks didn't make s difference, and therefore irrelevant to profit growth rates for the broad market.
Repurchasing stock at fair value does not increase the value of remaining shares at all.
A lot of people notice the EPS rising, but forget about the cash balance going out the door. Cash has value!
A buyback increases the value of remaining shares only to the extent that it's done below fair value.
And on average stock buybacks are not done at a discount to fair value, based on their observed high pro-cyclicality.
(lots of buybacks when stocks are expensive, and few when they're cheap).
Berkshire is one of the exceptions in that regard.

Rather, I suspect the huge upswing in US corporate profitability in the last 20 years is due to other factors.
Reduced competition and thus better "rent seeking",
combined with (and slightly dependent on) weakened share of profits going to workers, who are now competing with workers around the world rather than just across town,
and changes to corporate tax rates.
The combined effect, whatever the root causes, is big.
Average net margins 1947-2004 = 6.27%.
Average net margins 2005 to date = 10.00%
That gap is a pretty large fraction of GDP now going to shareholders which would previously have been going to workers and/or taxes.

Jim

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