Total Return, Capital Gains, and Income

In a recent article in "Monetary Trends" (a publication of the Federal Reserve Bank of St. Louis), William Emmons asks the question: "What Returns Can 'Buy-and-Hold' Stock Investors Expect?"

In making his point, Mr. Emmons provides an interesting table you might wish to use in conjunction with the capital market history discussions in Fundamentals and Essentials. The table appears below.

Holding Period	Total Return	Dividend Yield	Capital Gain	GDP Growth	Inflation
1926-1997	10.6	4.6	6.0	6.4	3.1
1946-1997	12.2	4.3	7.9	7.3	4.3
1966-1997	11.5	3.9	7.6	7.8	5.2

The data suggest a number of interesting (if unsurprising) things. First, as one might suspect, the proportion of total return attributable to dividend yield has declined over the last seven decades. And, of course, the rate of inflation has been, on average, higher in the postwar era than in the prewar period, and higher yet since the mid-1960s. Finally, nominal GDP growth has also accelerated in the postwar period.

Perhaps more interesting is the conclusion drawn by Mr. Emmons. He notes that "capital gains tend to track GDP over time" and since "[r]eal GDP growth is likely to average 2 to 3 percent annually and current inflation expectations are also 2 to 3 percent" and dividend yields are at historic lows, "one should probably expect total nominal returns on stocks to average no more than 5 to 7 percent in the future." In other words, the model suggests that future total returns will be about half the historical total return figures in the table.

What do you think? Raise this issue with your students. Are there mitigating or even contradictory arguments to be made here? What does this imply for decision-makers attempting to estimate the cost of capital for long-term projects?

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