I spend a couple of weeks every February keeping up with my investments, timing it to coincide with the release of Buffett’s annual letter to shareholders. I found something interesting while performing this ritual this time.
I came across Aswath Damodaran’s website, where he has compiled data on the S&P 500 index, including earnings, dividends, index levels, and other key metrics from 1960 to 2023. The table below shows the information from the year 2005.
| Year | Earnings Yield | Dividend Yield | S&P 500 | Earnings | Dividends | Payout Ratio | PE Multiple |
| 2005 | 6.12% | 1.79% | 1248.29 | 76.45 | 22.34 | 29.23% | 16.3 |
| 2006 | 6.18% | 1.77% | 1418.30 | 87.72 | 25.04 | 28.55% | 16.2 |
| 2007 | 5.62% | 1.92% | 1468.36 | 82.54 | 28.14 | 34.09% | 17.8 |
| 2008 | 5.48% | 3.15% | 903.25 | 49.51 | 28.45 | 57.46% | 18.2 |
| 2009 | 5.10% | 1.97% | 1115.10 | 56.86 | 21.97 | 38.64% | 19.6 |
| 2010 | 6.66% | 1.80% | 1257.64 | 83.77 | 22.65 | 27.04% | 15.0 |
| 2011 | 7.67% | 2.11% | 1257.60 | 96.44 | 26.53 | 27.51% | 13.0 |
| 2012 | 6.79% | 2.19% | 1426.19 | 96.82 | 31.25 | 32.28% | 14.7 |
| 2013 | 5.68% | 1.89% | 1848.36 | 104.92 | 34.90 | 33.26% | 17.6 |
| 2014 | 5.64% | 1.92% | 2058.90 | 116.16 | 39.55 | 34.04% | 17.7 |
| 2015 | 4.92% | 2.12% | 2043.94 | 100.48 | 43.41 | 43.20% | 20.3 |
| 2016 | 4.75% | 2.04% | 2238.83 | 106.26 | 45.70 | 43.01% | 21.1 |
| 2017 | 4.66% | 1.83% | 2673.61 | 124.51 | 48.93 | 39.30% | 21.5 |
| 2018 | 5.92% | 2.14% | 2506.85 | 148.34 | 53.61 | 36.14% | 16.9 |
| 2019 | 5.03% | 1.82% | 3230.78 | 162.35 | 58.80 | 36.22% | 19.9 |
| 2020 | 3.68% | 1.51% | 3756.07 | 138.12 | 56.70 | 41.05% | 27.2 |
| 2021 | 4.33% | 1.24% | 4766.18 | 206.38 | 59.20 | 28.68% | 23.1 |
| 2022 | 5.72% | 1.78% | 3839.50 | 219.49 | 68.34 | 31.14% | 17.5 |
| 2023 | 4.61% | 1.47% | 4769.83 | 219.70 | 70.30 | 32.00% | 21.7 |
I chose the year 2005 because that’s when I came to the United States with no savings, despite having worked for a decade. It was during that time that I discovered two influential role models who transformed my understanding of finance and investing: Warren Buffett and John Bogle. I was deeply convinced by their teachings.
Here are some important lessons that one can learn and relearn from the above table. There’s nothing new under the sun. It has all been said before. Simple to understand but difficult to follow especially during turbulent times.
Earnings fluctuate, but they compound over long periods. Growth in population (the world added 1.5 billion more people during this period), productivity, inflation, efficiencies, and tax rates have ensured that earnings compounded at an average annual rate of 7.7% during this period.
The Great Financial Crisis in 2008 caused earnings to shrink by 40%, and the index fell in value by over 50%. It took two years for earnings to regain the previous highs reached in 2006. I used to listen to one “financial guru” on the radio during my drive back home from work. This person would scream on the radio to sell index funds and hand over the money to them to pick the “right” stocks. Glad I ignored their advice.
Who would have thought in 2020 that humanity would be confined to their homes by a tiny virus invisible to the naked eye? Earnings shrank by 15% and the index fell by 30% in March 2020, but it bounced back to all-time highs before the end of 2020. This time, I was accustomed to the stock market volatility. I told myself that in a systemic failure, everyone is adversely impacted, and there’s not much one can do other than staying the course.
During this 18-year period, the index returned 9.65% with dividends reinvested. A bumpy ride but we ended up way higher than where we started.
Reinvested dividends are the unsung heroes of wealth creation. Growth doesn’t come for free. Companies need to reinvest their earnings to expand. However, they don’t require all their earnings for growth. The excess is returned to shareholders in the form of dividends and share buybacks. During this period, the average dividend payout ratio was around 35%.
For example, the dividend was $22.34 in 2005 with a dividend yield of 1.79% ($22.34/1248.29). In 2023, the dividends increased to $70.30, and the dividend yield on the original price is 5.6% ($70.30/1248.29). Your yield continues to go up just from sitting quietly without doing anything.
Let me give a specific example to drive home the importance of dividends. Microsoft’s quarterly dividend per share soared from $0.08 in 2003 to $0.75 in 2024, marking an 11.25% CAGR in dividends. Even more impressive, considering the $25 share price in 2003, the current 12% dividend yield means your initial investment could be fully recovered in just 8 years.
During this 18-year period, the index returned 9.65% with dividends reinvested, even though earnings only compounded at an average annual rate of 7.7%. The remaining 2% of returns came from reinvested dividends. If you think that 2% is insignificant, consider the table below showing the substantial difference between returns with and without reinvested dividends.
Survive and hold on to the winners: The magic of compounding occurs when you can either compound at an exceptionally high rate (R) or compound at reasonable rates over an extended period (N) or do both. What indexing allows investors to achieve is a scenario where, even though the R (rate of return) might be around 7-10 percent, the N (number of compounding years) is significantly long.
Remember, N acts as an exponent in the compounding formula, facilitating the occurrence of what is often referred to as the 8th wonder of the world. You can only capture the power of N by surviving in the market, and indexing provides that survival, provided you can control your emotions.
The table below presents the top 10 companies in the S&P 500 for 2005, ranked by market capitalization. Before we explore the top 10 companies of today, could you guess how many from the 2005 list have managed to maintain their top 10 status up to the current day?
Microsoft was the only company from the top 10 in 2005 that remained in the top 10 by market capitalization in 2024. Microsoft’s stock had languished for almost 15 years after missing the internet, social, and mobile wave. It managed to revive its fortunes by capitalizing its deep relationship with enterprise customers and embracing the world beyond Windows and surfed the cloud computing wave.
Our faces remain unchanged even as our skin cells die and new cells are formed every 30 days. In a similar way, companies within the index may come and go. General Electric was in the top 10 in 2004, while NVIDIA holds that position today. It’s hard to predict which companies will dominate the top 10 in 2040, but it doesn’t matter. The index will continue to hold onto the right ones as the composition evolves.
Investors’ moods fluctuate like a pendulum. When investors are pessimistic, they would only pay 13 times earnings. When they’re exuberant, they would pay 27 times earnings. We can’t control the mood of the market. What we can control is how we behave during those extremes.
Can we resist bailing out during difficult times? We get extra bonus points if we have the guts to deploy additional capital during market lows, like what happened during the 2008 financial crisis or the 2020 COVID crisis.
During market lows, I always revisit Buffett’s hamburger analogy: “If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.”
You only pay taxes when you sell the investment. Many people don’t grasp the impact of deferred tax liabilities. Let me break it down with an easy example. An investment of $10,000 in 2005 would grow to $52,500 over 18 years with a compound interest rate of 9.65%. If the investor were to draft a hypothetical balance sheet, it would appear as shown below.
I’ve assumed a long-term federal tax rate of 15% and included an additional 10% for California state tax, resulting in a total tax rate of 25% on the gains. We aren’t required to pay the government until we sell the investment. Essentially, the government permits us to compound this liability, allowing payment only at the very end. This advantage is another superpower that many investors overlook.
To make this concept even more clearer, let’s assume you invested $1 in 1980, and the investment doubles every year. You held onto it for 10 years, following a buy-and-hold strategy. At the end of 10 years, your gain is $512, with a total deferred tax of $76.80 at 15% federal tax rate.
Now, consider a different scenario where the investment doubles every year, but you sell your holdings at the end of each year, paying a 15% tax rate. You repeat this process for 10 years. In this scenario, your earnings are $253.83, just half of what you achieved with the buy-and-hold strategy. Additionally, the total taxes paid to the government amount to $44.62. In the buy-and-hold case, the deferred tax is $76.65. Thus, even the government benefits more from the buy-and-hold strategy.
I’d like to conclude this post with quotes from John Bogle, who simplified investing for ordinary individuals like myself.
- The winning formula for success in investing is owning the entire stock market through an index fund, and then doing nothing. Just stay the course.
- The two greatest enemies of the equity fund investor are expenses and emotions.
Start investing early. Spend less than you earn. Invest the savings in a diversified index fund. Remain patient and steadfast in your approach. Echoing the memorable words of John Bogle, “stay the course.” The eighth wonder of the world will ensure the growth of your corpus over extended periods.
Seeking Wisdom 