U.S Investors Expecting 17.5% Long-Term Returns

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In their recent episode of the VALUE: After Hours Podcast, Taylor, Mitchell, and Carlisle discussed U.S Investors Expecting 17.5% Long-Term Returns. Here’s an excerpt from the episode:

Jake: I’m calling this, “What are we thinking?” This came to my attention, there was a global survey of individual investors put on by this company called Natixis, I think it is. I don’t know. Not sure exactly how they say that. They surveyed 8,550 investors in 24 countries, and it turns out that US investors expect 17.5% returns from their equities for the long term, and converse that with professionals who are telling them that they should expect something more like 6.7%. We have a huge mismatch in professionals versus retail investors.

Now, I wanted to just walk through a little bit of math that I did back of the envelope of what would it take to make that 17.5% return per year materialized over 10-year period, which we’ll call the long-term? When I did the numbers, the price of the S&P 500 was $4,411. Let’s start there. Earnings per share were $131.5, which by the way are lower than December 2019’s peak earnings of $147.5. We’re already on the other side of maybe of earnings potentially growing, but forget about that. And profit margins at 12.6% right now, which is about double the long run average. But never mind all that as well.

The last 10 years, that EPS has been growing at a 2.3% CAGR. I’m going to take the last 10 years’ worth of growth, and assume that that’s going to be the same for the next 10 years, which gives you about a 25% total improvement in earnings over the next 10 years. That would put earnings per share at about 165 in the year 2031. Well, if we are going to have the price go up at a 17.5% clip, which is what the expectation is, then we would need the price then of the S&P to go from $4,411 to $22,126. It’s a 5x. You get 5x on 17 and a half for 10 years.

Michael: First of all, that seems totally reasonable, number one.

Tobias: [laughs]

Michael: Second of all, you’re a Debbie Downer for even bringing that up. [crosstalk] good question about that makes sense or not.

Jake: So, you’re telling me there’s a chance.

Michael: There’s a chance.

Jake: If assuming that, what does that then mean? That would mean the PE of the S&P 500 at 34 today would have to go to 134 in 2031. I will let you debate as to whether you think 134 is a reasonable amount to pay, but I– [crosstalk]

Tobias: [crosstalk] 10-year. Just tell me where is the 10 year is?

Michael: Negative 15.

Jake: Negative 25.

Michael: [laughs]

Jake: I tackle this another way, too. Let’s say that earnings you think are– Let’s forget about earnings. Let’s look at sales. Over the last 10 years, sales of the S&P 500 have grown at a 2.9% clip, so that would give you a total of 33% growth over the next 10 years. If we project that forward, sales then would turn out to be 1,855 in 2031, and that same price that we’re using, that means price to sales would have to go from the today’s current of 3.1, which is already very, very high if you look at a price to sales chart, but it has to go to 11.9.

Scott McNealy: What Were You Thinking

Jake: This reminds me a little bit of Scott McNealy’s, what were you thinking that he did about Sun Microsystems shareholders, when he told them, when it was trading at 10 times price to sales, and this is assuming we’re going to get to 11.9. But when it’s trading at 10 times, that’s basically saying that, I’m going to have to give you 100% of revenue is going out the door to you as a dividend, which means that, I have no cost of goods sold, which is not very reasonable. It means I’m not paying any taxes as a corporation, which is illegal.

It means I don’t pay any employees, which it’s hard to imagine how I’m going to deliver on that. It means there’s no R&D for the future to keep maintaining this business. All of which, it all has to go out the door for 10 straight years to you, if you’re going to get your money’s back on a 10-time price to sales. By the way, Sun went from $5 a share up to $64 roughly, and then back down to $5 again.

Here’s another way of looking at it. Let’s say that we got out to 2031, and we assume that the PE had gone back to a more normal 15x, which we can have debates about whether that’s a new normal, we’ve been higher than that. But anyway, we would have to have earnings grow. I’m just doing the math in a different way, kind of backwards, but earnings would have to grow at a 27% clip from today until 2031.

By the way, they’ve grown at a 2% clip, but they’d have to grow at a 27% clip to get to that same earnings number that would justify a 15 PE. In the last 32 years, earnings have grown five times at a 27.4 or greater amount, and those were typically off of a really low base, like 2008. The year before that it was down way more, and then, you get a big up year on a return to normal. Zero times in the last 10 years has it grown at a 27.4% clip. But we’re going to do that for 10 straight years back-to-back-to-back-to-back-to-back. What are we thinking?

Michael: I’m not part of the 17% camp. I don’t know what those people are. Can you imagine the source– people already talked about wealth disparity for those that have a lot of capital assets versus those that don’t, can you imagine what it would look like 10 years from now, if those that own stocks were up 17% compound- [crosstalk]

Tobias: Guillotines.

Michael: -people who didn’t? That just blows my mind. Jake, while we’re talking about this, you can go do the math. I know you’re able to do that quickly, but no, I’m just kidding. Don’t do the math.

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