Where to seek 8% p.a. for the next decade

Marcus Tuck

Mason Stevens

In this note, we look at what the Bogle Model currently forecasts for average equity returns in the US and Australia over the next decade.

Over the long term, stock market returns are derived from the market dividend yield plus the subsequent rate of earnings growth. Over shorter periods, speculative returns derived from changes in the market PE ratio can figure prominently, as investors change their view as to how much they are willing to pay for each dollar of corporate earnings. In the long run though, the impact of the speculative return washes out.

This is confirmed by empirical evidence. Over the last century, the US stock market returned 9.6% p.a., closely matching the 9.5% “investment return” comprised of 4.5% from dividend yield and 5.0% from earnings per share (EPS) growth. In other words, the “speculative return” was only 0.1% p.a.


This insight lies at the heart of the so called “Bogle Model” which attempts to estimate average equity returns over the next decade. The key inputs are the starting dividend yield for the market, the estimated long-term rate of EPS growth, and an adjustment to normalize the market PE ratio (i.e. bring it back into line with the long-term average). When the market PE ratio is above average, it is expected to de-rate over the next decade thereby reducing the expected equity return, and vice versa.


In order to use the Bogle Model to forecast average equity returns over the next decade, we need to know the starting dividend yields and the current market PE ratios compared to their 10-year averages.

They can be seen for the US S&P 500 Index in the first chart below.



The 12-month forward dividend yield for the S&P 500 Index is 2.0%, the long-run EPS growth expectation is probably still about 5% (3% real + 2% inflation), and the 12-month forward PE ratio for the S&P 500 is currently 16.8x, which is 2.1 PE points above the 10-year average of 14.7x.


Therefore, the Bogle Model predicts average US equity returns over the next decade of: 2.0 + 5.0 + (14.7 - 16.8) = 4.9% p.a.


Turning to the ASX 200 Index, the picture is as follows.


The 12-month forward dividend yield for the ASX 200 Index is 4.5%, the long-run EPS growth expectation is around 5% (3% real + 2% inflation), and the 12-month forward PE ratio for the ASX 200 is currently 15.5x, which is 1.5 PE points above the 10-year average of 14.0x.


Therefore, the Bogle Model predicts average Australian equity returns over the next decade of: 4.5 + 5.0 + (14.0 – 15.5) = 8.0% p.a.


That is not greatly different to the actual market return of the past decade, which, with dividends reinvested, was 8.4% p.a. That analysis (and historical market return) does not take into account the additional benefit of dividend imputation, which is often overlooked.


If we attempt to include franking in the expected return (recognizing that not all listed companies pay fully franked dividends), the Bogel Model calculation would become: (4.5 x 100/70 x 0.65 + 4.5 x 0.35) + 5.0 + (14.0 – 15.5) = 9.3% p.a.


The Australian stock market has actually been one of the highest returning stock markets in the world over the past century, partly because our dividend yield is usually always quite high to begin with. There will always be year-to-year volatility but, where things stand at the moment, the average return for Australian equities over the next decade may not be that different to what it was over the past decade, although there will be moments when it won’t feel like it.


This article is prepared by Mason Stevens Limited (Mason Stevens) ABN 91 141 447 207 AFSL 351578 and is general advice only and does not take into consideration yours or your client’s personal objectives, financial circumstances or needs and should not be relied upon as personal advice. You should consider this information, along with all of your other investments and strategies when assessing the appropriateness of the information to your individual circumstances. Securities, by nature, rise and fall and as a result investing in securities including derivatives involves risk. Past performance is not a reliable indicator of future performance and may not be achieved in the future. Mason Stevens and its associates and their respective directors and other staff each declare that they may hold interests in securities and/or earn fees or other benefits from transactions arising as a result of information contained in this article.

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Marcus Tuck
Marcus Tuck
Head of Equities
Mason Stevens

Responsible for identifying domestic and international equity investment opportunities. 25 years of financial markets experience as an equity strategist, economist, analyst, portfolio manager and consultant.

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