Deconstructing earnings and valuations

One way to look at market returns is to deconstruct them into their three parts: dividends, earnings growth, and changes in valuation. Here we see how different the US market has been from other parts of the world. In the Earnings & Valuation: USA chart we see that over the past 12 months, dividends contributed 1% of the return, earnings 8%, and changes in the P/E-multiple 22%. A decent earnings gain has been greatly amplified by a significant multiple expansion.

Contrast that with emerging markets, which produced the same 8% earnings, 3% from dividends, but only 1% from multiple expansion.

There are a number of reasons for that dispersion, including differing payout ratios (EM companies have tended to dilute shareholders, while US companies have tended to buy back way more shares than they issue), and of course the concentration of the Mag 7, which only the US has. In the Equity Valuation chart we see that while the equal-weighted S&P 500 continues to look OK at 19.8x trailing earnings, the cap-weighted index is approaching the 2021 “mini-bubble” extremes.