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By Jeremy Glaser and Matthew Coffina, CFA | 08-20-2013 02:00 PM

Coffina: Stocks Still Best Vehicle for Long-Run Wealth

It's unlikely we'll see the 6.5% long-run real returns of the past decades, but 4.0%-5.5% returns going forward shouldn't disappoint investors, says StockInvestor editor Matt Coffina.

Jeremy Glaser: For Morningstar, I’m Jeremy Glaser. I’m joined today by Matt Coffina; he is the editor of Morningstar StockInvestor. He has recently completed some research into what's driven stock returns over time. We’re going to talk to him about what some of those factors are, and also his expectations for returns going forward.

Matt, thanks for joining me today.

Matthew Coffina: Thanks for having me, Jeremy.

Glaser: Benjamin Graham famously said in the short term the market is a voting machine, but in the long term it’s a weighing machine. When you look across the last 100 some years of stock market performance, do you find that to be the case?

Coffina: I think very much so that that's the case. If we look at the drivers of stock market performance over the very long run, there is a very clear connection between dividend returns, dividend yields, increases in real earnings, and then changes in the price/earnings multiple being the big swing factors in the short run. But over the very long run, it's really those first two factors, dividend yields and real earnings growth, that drive real afterinflation returns.

Glaser: Eventually the stock market really does follow those fundamentals. Looking across those factors, which ones did you find were the most important, and have those factors changed over time?

Coffina: What’s interesting is that dividends used to be a much larger contributor to the markets real afterinflation returns than they are today. Payout ratios and dividend yields have been falling steadily over the last 50 years or so, such that now the yield on the S&P 500 index is only about 2%, whereas it used to routinely be in the midsingle digits.

You could ask what does this mean for returns going forward. What's interesting is you would think from finance theory that the lower dividend payout ratios go, the higher real earnings growth would be. And that hasn’t really been the case. Real earnings growth has picked up some of the slack for lower dividend yields, but not all of the slack that’s left there, which to me indicates that companies on average are not necessarily making the best investments with the capital that they’re retaining. Maybe they're repurchasing stock at inopportune times, they’re overpaying for acquisitions, they’re making bad internal reinvestment decisions, and so on.

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