The combination of stock buybacks and dividends make up a lion’s share of total stock returns over a long period of time. When buybacks and dividends are reinvested at lower prices it leads to higher long term reviews then when they are reinvested at high prices. There are many examples of this in history like the South Sea Company bubble. Imagine how much worse stock returns would have been over the next 100 years if the market went sideways from one of the peak of one of the bubbles of the past which had valuations of a single company at almost $8 trillion dollars (inflation adjusted). Dividends would have been reinvested at sky-high prices, and investment returns would have suffered.

Unfortunately, there is not great data from the 1600s and 1700s to quantify this, but we can look to more recent history to the great depression. In this post, we look at how different 30-year returns might have been, if the stock market had marched slowly upward starting in September 1929 and ending September 1959 instead of enduring the drawdown and volatility of the great depression.



In both of these scenario’s the start and end price is the same, but the actual scenerio has the benefit of reinvesting dividends at much lower prices. When you reinvest those dividends monthly this is what the nominal return looks like in each scenario.



This leads to a nominal return of 5.76% CAGR in the actual time frame compared to if a 2.79% nominal return, if there was no great depression and stocks, marched slowly upward instead. After adjusting for inflation the CAGR in the actual time frame was 3.92% compared to 1.01% if there was no great depression.



While this analysis is far from perfect(imagine the innovation with such low cost of capital), this outperformance of nearly 3% compounding has implications for today or any market in the future. One of the major reasons stocks have performed well in the past is the power of compounding earnings being reinvested at lower prices than we have today. At today’s prices, we should not expect this reinvestment to be as efficient. The CAPE ratio was only around 20 at the peak before the great depression compared to over 30 today. This implies that the power of reinvestment is even worse today than it was at the beginning of the great depression as asset prices are more inflated by the greater fool.

One of the best things that could happen to stock market returns over the next 30 years is having stock prices much lower for as long as possible. Even if valuations stay high forevermore, the power of compounding would be more limited and lower returns should be expected in the absence of further multiple expansion. What can the rational investor do? Lower equity asset allocation in the face of lower anticipated returns.

