Why The Price Dividend Ratio Is Better Than PE Ratio
Published October 13th, 2008 in Trading Tags: fundamental analysis, John Bogle, PD ratio, pe ratio, price dividend ratio, price earnings ratio, stan weinstein, valuation.
The PE ratio needs no introduction. For a very long term chart of the ratio, click on the image to the left. The source of the chart is the NY Times with a helping hand from the economist, Robert Shiller. I was surprised to see that we were trading at a higher PE ratio as early as last year, than the top in 1929!
The graph above is based on the average earnings for the preceding 5 years. This chart is more short term, based on the rolling 4 quarters of earnings:
Why Use the Price Dividend Ratio?
I’m not sure where I first learned about this ratio. But Stan Weinstein really made it stand out for me as a very important measure of market valuation in his book: “Secrets For Profiting in Bull and Bear Markets” The power of this ratio comes from the fact that unlike earnings, dividends can not be “massaged” by creative accounting. There are no “EBIT” dividends. They are completely immune from accounting shenanigans. They are either declared and paid in cash or they aren’t.
Also dividends are free from the year to year shocks such as “write-offs” which can affect earnings. Most companies treat their dividends with what you might say approaches reverence because dividends send such a clear and strong signal about their financial strength.
I’m loathe to dip into the fundamental analysis toolbox but from time to time, when the situation warrants, I do. But for the reasons above, I prefer to use the price dividend ratio instead of the much more popular price earnings ratio.
Basically, the ratio tells you how much you have to pay for $1 of dividends. So in a way it can be equated to the “yield” coupon of the stock market. Or the inverse dividend yield of the stock market. And because of that, it has some correlation to the interest rate. So when interest rates are high, usually the dividend yield is also high.
Here is a very long term chart of the S&P 500 Index. I’ve added two data points, one for where we were this time last year and one for now:
Source: Federal Reserve Bank of San Francisco
Dow Jones Price Dividend Ratio
A year ago, when the Dow was at ~14200, the price dividend ratio was 49. Meaning you would have had to pay almost $50 to get $1 of dividends a year. It also corresponds very closely to the S&P 500’s price dividend ratio (above).
As of now, however, the Dow’s price dividend is a more reasonable 26. This is because of two things. First, and most obviously, the Dow has come down a lot, but also importantly, dividends have increased a healthy 11.7% from a year ago.
As you can see from this long term chart of the Dow’s price dividend ratio, we are right around the long term average for this ratio:
Source: John Bogle on Mutual Funds
As we’ve all noticed in the past few days, the market has the ability to reach maximum levels and then to keep pushing into new territory (I’m looking at you VIX). So just because we are now at a much more “normal” price dividend level doesn’t mean that it can’t go lower. For example, here’s a really scary picture of what might/could happen.
Having said that, I’m glad to see this fundamental ratio not clash with other technical indicators which are pointing to a potential market bottom.
The charts above are long term but do not show the most recent years, so if you know of a more up to date price dividend ratio, I’d love to see it. Or if you have access to a platform like Bloomberg, where you can look it up, send me a screengrab. I’m sure the most recent data holds some insight.
fundamental analysis, John Bogle, PD ratio, pe ratio, price dividend ratio, price earnings ratio, stan weinstein, valuation
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10 Responses to “Why The Price Dividend Ratio Is Better Than PE Ratio”
- 1 Trackback on Oct 28th, 2008 at 5:06 pm
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Very informative analysis TN
I’ll be sure to pass it along to my readers!
yea good points here. i hadn’t looked at this ratio in forever, thanks for the reminder!
I’m surprised that as of Friday the S&P PE ratio based on trailing 4 quarters was as high as 17.2. Although not outrageously high, it’s not cheap either. And since one can reasonably expect earning to decline in the coming year, that would suggest we are not undervalued. The correction hasn’t gone far enough?
When earning goes down, expect those companies cut the dividends.
I’m not sure that a long time series of D/P ratios provides as much of an “apples-to-apples” comparison as a long time series of P/E ratios, as companies have dramatically altered their attitudes about paying dividends since the 1990s. This means that low D/P ratios don’t measure overvaluation in the same way that they did 1950-1990 (and vice versa for high D/P’s). Another point, since you quote Shiller — his work (with John Campbell) forcefully emphasizes that the most informative P/E series is the one with 10-year smoothed earnings in the denominator, rather than the one you plot, with 1-year trailing earnings. I enjoy your blog, keep writing. http://marketblog.wordpress.com.
Rob, you make good points. However, re the difference in approaches to dividends over time, the same thing could be said of earnings. In the old days they never used as much financial engineering as they do today to get earnings just right. They also didn’t have “whisper” numbers, EBIT, etc. Time series comparisons have all sorts of issues but that goes across the board.
I have no doubt that if an executive from 50-60 years ago saw how the earnings management game is played today they would be appalled. Nonetheless, I still maintain that the profound shift in companies’ willingness to pay dividends accounts for much of the decline in the market D/P ratio. Notice the disconnect between the market D/P and P/E even today. After Tuesday’s 9% decline in the S&P 500, the market P/E indicates that stocks are priced to deliver average long-term returns again (meaning that if you bought in at today’s levels, 20 years from now you probably will have earned close to 10% per year). But the current market D/P suggests stocks are still profoundly overvalued, which — at least to me — does not make sense. Thanks for your reply.
Ok guys this is great information. I think what Rob is saying is lets factor growth into this since growth = future increased dividends or an increase in stock price (typically).
So where can we get this data integrated with growth graph it and look at the dow and maybe any stock (and do it fast).
Great work!
Robert Shiller of Yale makes the data available for free on his website: http://www.econ.yale.edu/~shiller/data.htm. You can download everything you need in one Excel file (monthly values).