Growth matters more than any other contributor to return for stock investors. Although this may seem strange to say for a “value” manager like us, it is an undeniable fact. We know this because, in the fullness of time, economic growth is the primary driver of profits which, in turn, drive long-run stock values. The faster the potential growth rate for an economy, the faster the potential growth rate for-profits, and the greater the potential return for the stock market. So, we feel compelled to remember the dominant role of economic growth in shaping the long-run outlook for stocks.

To put a finer point on this, we can decompose the return of a stock market into four parts:

1) growth in sales;

2) growth in profit margins;

3) growth in the multiple investors pay for those profits;

4) dividends received

The first three of the above points are limited over time. Sales cannot grow faster than the economy forever, else corporate sales will eventually exceed the size of the whole economy. Profits cannot rise more quickly than sales forever; otherwise, workers’ wages would decrease toward zero. Nor can stock valuations rise without limit, because investors will not pay ever more irrational prices for a unit of future earnings. Equally important, we know sales, margins, and multiples cannot contract ceaselessly for reasons opposite those just mentioned.

Carrying this logic further, we find sales and dividend growth (by extension economic growth) are the things that overwhelmingly matter most to long-run equity market returns. While margins and valuations can matter over short horizons, growth in either tends toward zero over the long-term, making them less important in the end. Yet, given the tendency for large year-to-year swings in margins and valuations, they can have an outsized influence on short-term returns.

The Evidence (1991-2021)

The past 30 years delivered strong returns to stock investors, and the table below decomposes the source of the returns (Table A). From the third quarter of 1991 through the third quarter of 2021, the price of the S&P 500 rose at an 8.5% annualized rate. If we add dividends, the total return increases 10.6%, implying a 1.9% dividend return. Of the 8.5% return, we attribute 3.7% sales growth; 3.7% to margin expansion; and 0.9% to raising multiples. We also see the “pieces” of the return are very different in terms of volatility and predictability. While sales growth tends to have low volatility (more durable), margins and multiples have very high volatility (more fickle). Volatility can be clearly seen in the final column of the table below.

Table A
Decomposing 30 Years of S&P 500 Returns
(Third Quarter 1991 – Third Quarter 2021)

1991Q32021Q3Annual Return
(Standard Deviation)
Profit Margin3.8%11.1%3.7%22.3%
Multiple (Price/Earnings)21.2x27.6x0.9%22.5%
S&P 500 Price Return3854,4218.5%
Plus: Dividend Return1.9%
Equals: Total Return 10.6%

Source: WCA; Bloomberg

1. Volatility is annualized standard deviation, a measure of the amount of variation or dispersion of a set of values. A lower standard deviation indicates lower observed volatility.

A Look at Multiples & Profits

Stock market price-to-earnings multiples are above the long-run, cyclically-adjusted average (Chart A, Top). Today, we see the market trading at 37x versus a 26x historical average based on ten-year cyclically-adjusted earnings. This 40% premium, if spread out over a ten-year forecast period, reduces return expectations by 4% in our base case (40% premium / 10 years = -4% per year). To assume otherwise would be to assume that stocks are now valued at a new permanently high valuation plateau.

Profit margins stand at all-time highs (Chart A, Bottom). S&P 500 profit margins (profits/sales) ranged from about 1-11% of GDP from 1947-2008 and are near 11% today. Margins were in the 8-10% range for most of the past decade, excluding recessions. Globalization, technological change, eroding union power, availability of inexpensive financing, changes in business size and scale, and other factors all combined to lift profit margins through the years. The surge in post-pandemic activity is also boosting profits above trend. As we expect margins to “revert to the mean” post-pandemic, we expect some drag on profits and long-run return (roughly 1-2% per year) in our base case.

Chart A


The rise in multiples and margins above trend in recent years helped drive indices to records. We do not think margins and valuations are at a new, permanent high. Mean reversion is still part of our base case forecast. We believe that such reversion will likely detract a few percentage points from long-run equity returns.

Kevin R. Caron, CFA
Senior Portfolio Manager

Chad Morganlander
Senior Portfolio Manager

Matthew Battipaglia
Portfolio Manager

Steve Lerit, CFA
Senior Risk Manager

Paul Clark, CFA
Senior Portfolio Manager
Municipal Fixed Income

Rick Marrone
Senior Portfolio Manager
Municipal Fixed Income

Daniel Urbanowicz
Senior Portfolio Manager
Municipal Fixed Income

Suzanne Ashley
Internal Relationship Manager

Eric Needham
Director, External Sales and Marketing

Jeffrey Battipaglia
External Sales and Marketing


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