Price to Dividend Ratio Says Stocks Are Expensive

The stock market price struggle is on. Will prices continue to advance from their March 2009 lows or will they retreat? Of the many metrics to use to value stocks, the ratio of current price of the S&P 500 divided by the dollar amount of S&P dividends is very useful to spot when stocks are expensive or not.

The ratio tells us how many dollars of the S&P 500 it takes to buy one dollars worth of S&P 500 dividends. For instance, a ratio of 60 means that it takes $60 to get one dollar of dividends. The ratio increases as the S&P 500 rises or as dividends fall. On the other hand, if prices fall or dividends rise, the ratio decreases.

The next chart shows values of the price to dividend ratio for each month from January 1900 through September 2009 (price and dividend data from Robert Shiller.) Until mid 1995, the ratio varied from between 10 to 38 in a period that experienced significant events including the 1929 stock market crash, the depression stock market low of 1932, the 1973/1974 recession, the 1987 one-day crash and the 1982 beginning of the great bull market.

But in mid 1995, the ratio exploded to the upside as stock prices took off to form the great bubble that eventually burst in 2000. After peaking in March 2000, the ratio headed to the downside to bottom in March 2009. Since then, the ratio has followed stock prices to the upside.

As of September 2009 the ratio stood at 43, just above the upper boundary of its historical range of values. For the ratio to fall within the historical range, either stock prices need to decline or dividends need to increase. Dividend increases are unlikely in the current weak economy so that leaves falling prices as the mechanism to drive down the ratio.

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Posted November 10, 2009

Price to Dividend Ratio Says Stocks Are Expensive

Price to Dividend Ratio Says Stocks Are Expensive