The ever-expanding margins and valuations of the past decade are unlikely to be sustained


Danton Goei: This looks at what the return of the market has been and how that has been achieved over the last 13 years since the financial crisis. So if you look all the way in the right, the big blue bar, we've achieved over 13% a year for 13 years, obviously in aggregate, a pretty good period. We all know there's been a lot of angst at different periods of time over those 13 years, but on average, pretty good period. And how has that been achieved? Well, one has been earnings, and that's the first blue bar on the left, of 5.7% growth. And that's been a composite of revenue and margin. And then the earnings per share, close to 5.8 because buybacks have only been a modest contributor.

But then you look at the price return and it's much, much larger than the earnings per share growth. And that is because the PE multiple, that PE multiple expansion, has been a massive contributor. And then finally, dividends have contributed about 2% a year to get us to our 13% a year over that time period. And I'd like us to just take a step back and think about, "Okay, so margin has been a big contributor and PE expansion has been a big contributor, how likely are those to be big contributors going forward?" And let's look at margins first. So this is here a chart since 1946 of operating profits for the S&P 500, and you can see where we are now. Obviously much, much higher than the average of 6.1% or close to 10%. So I think it's pretty clear that we can't expect margins to be a tailwind going forward.

And we think about what influences margins, labor costs, interest rates, tax rates, none of those things are likely to be contributors. In fact, they might be headwinds going forward. If you think about the cost of labor and wages and what's happening now, and we can see what's happening with strikes and things like that and the increases in wages, interest rates obviously are higher, and tax rates are possibly higher in the future. So let's set aside our aspirations for a tailwind for margins. How about PE expansion? Well, here again, you can look at the long-term data and see what the average has been. So it's been about 15.8 times and we're now at close to 20 times. So again, possible, but just highly unlikely from our starting point today, that margin expansion, which you saw on that first chart, has been a big, big contributor to the returns and the outperformance of the market versus historical returns.

And again, so those two big things, we have to understand where we are starting now, and those are very unlikely to be contributors going forward. Doesn't mean that you can't do well. You can find companies that are going to do well despite not having margin expansion and not having a multiple expansion. If you can find those companies and they're trading and attracting multiples, you can do well, but you don't want to depend on those things, margin expansion, multiple expansion, to do well.

Related Videos


Davis NY Venture Fund – A Complement or Alternative to the S&P500

Our highly selective portfolio of durable companies with attractive growth – at a greater than 40% discount to the S&P500 – may be a viable compliment or alternative to index positions


A Return to Rationality

Traditional business fundamentals are finally being rewarded again, driving our performance

Share this Video