Reed Between The Lines

Reed Between the Lines: The Ingredients to Market Performance

20 February 2020

By: J. Reed Murphy, CIO

Contributions by: Rob Young, CFA 

Earnings? Dividends? Or Valuations? What Ingredients Really Matter?

Cooking is a skill and for some people it’s a passion—a therapeutic outlet. Meal preparation involves many variables including ingredient selection, available tools and technique. To the literal end- consumer, performance is based on taste; with all other contributing variables being negligible. After all, if a meal is satisfying, then who cares how it was made? Well, most people don’t.

Investing in the U.S. equity market can be viewed through a similar lens. At the end of the year an investor can look back and assess whether what the market served up was good or bad. After the initial reaction, a market connoisseur may wonder what the primary contributors to their performance were AND are those contributors expected to last?

Let’s take a closer look and read between the lines. How do the components of stock price, earnings per share, dividend and valuation multiple combine to give us bottom line performance? The following exhibit illustrates the contributors to various return scenarios.


Source: Calamos Wealth Management. Note: This is a hypothetical example to be used for illustrative purposes only. Hypothetical performance is no guarantee of future results.


As just reviewed, the three primary mathematical components of a stock (or market) price movement are; 1) Earnings per share (EPS) growth, 2) Dividends and 3) Valuation Multiples (Price to Earnings Ratio).  From 1955 to 2019, the contributors to the S&P 500 performance came from the following (total equals 100% per year).

However, when we look at the variance of the annual contributions of those components there is a dramatically different story. First, while over the long-term the valuation multiple showed the lowest contribution level, its contribution level on an annual basis varies dramatically. It has the highest variation of outcomes (i.e., highs and lows). This translates into significant swings in market returns from year-to-year.

Second, dividends are rather constant with a standard deviation (variance of data points around its average) that is very tight relative to Earnings per Share Growth and Price to Earnings Valuation Multiples. Said another way, the variance in highs to lows is tight with a low standard deviation and vice versa.


Based on an examination of these contributions on an annual basis, it is easy to surmise companies that pay dividends, in general, tend to be less volatile than companies that do not. Due to the compounded return impact of dividends and the assumption that those dividends are reinvested, the result is that dividends represent 86% of the cumulative return of the S&P 500 since the beginning of 1955 through 2019. (Bloomberg; Past performance is no guarantee of future results.)


While all of this seems rather technical, evaluating this in context of where the market’s return came from over the last few years is enlightening. The S&P 500 return for 2019 of 31.5% was the best annual return since 2013, but the ingredients of its return profile was as different from 2018 as my cooking is relative to a Le Cordon Bleu-trained chef.  In 2019, nearly 92% of the return was driven by an expanding valuation multiple (i.e. investors paid a higher-dollar-value-per-unit of income).  In 2018, the opposite occurred with earnings growth flaring up and valuation multiples acting as a flame retardant (Exhibit 3).



Source: Calamos Wealth Management. Bloomberg. Periods analyzed December 31, 1995 – December 31, 2019. Earnings Growth = Earnings per share growth year-over-year. Dividend yield is the annual contribution of the dividend yield reinvested. S&P 500 index is an index of the 500 largest corporations by market capitalization listed on the NYSE or NASDAQ. Past performance is no guarantee of future results.

As we look to 2020 we believe the following provides a base case scenario.

As we consider these elements on a forward looking basis, it is important to note that investors may be well served by international equity exposures. These markets are cheaper on an absolute and relative basis with higher dividend yields and earnings growth expectations overall; perhaps to further our beginning analogy – these exposures provide the spice to what could be another year in the markets to potentially savor. Please consult our full market commentary for our broader views on the markets and investment implications.


Please remember that past performance may not be indicative of future results. Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations. The information contained therein is based on internal research derived from various sources and does not purport to be statements of all material facts relating to the information mentioned, and while not guaranteed as to the accuracy or completeness, has been obtained from sources we believe to be reliable. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Calamos Wealth Management LLC), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. 
Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Calamos Wealth Management LLC.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  Calamos Wealth Management LLC is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.  If you are a Calamos Wealth Management LLC client,please remember to contact Calamos Wealth Management LLC, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. A copy of the Calamos Wealth Management LLC’s current written disclosure statement discussing our advisory services and fees is available upon request. 
Earnings Growth = Earnings per share growth year-over-year.
Dividend yield is the annual contribution of the dividend yield reinvested.
S&P 500 index is an index of the 500 largest corporations by market capitalization listed on the NYSE or NASDAQ.
Standard Deviation is a statistic that measures the dispersion of a dataset relative to its mean.
Variance in statistics is a measurement of a spread between numbers in a dataset.