no bubble

JW Mason jwm at
Mon Apr 10 21:21:01 PDT 2000

Hi all.

Inspired by discussion on these lists and by a talk Dean Baker gave here on the stock market the other day, I decided to take a look at total payouts to shareholders, defined as dividends minus net new equity issues. (The latter being negative in recent years.) The price-payout ratio, then, is the market value of equity divided by the total payout. This is for nonfinancial, nonfarm corporate businesses, from the Flow of Funds.

The results were interesting.

1999's price-payout ratio, 36.8, was almost exactly equal to the postwar average of 35.3. Even though the price earnings ratio is over twice its historic average, the proportion of profits being paid out to shareholders, 74.4%, is also over twice its historic average of 35.1%.

If you consider the period of irrational exuberance to date from 1996, as Doug suggested at his Socialist Scholars talk, the results are even more striking: the price-payout ratio for those four years is only 29.2, well below its long-term average. (The proportion of profits paid out to shareholders over this period is 76.1%; in 1998 it exceeded 100%.)

By this measure, there is no bubble. There is no reason to believe that share prices are being bid up simply in the expectation of future price increases. Investors seem to be valuing the claim on profit income represented by shareownership at about the same level they always have.

If investors aren't behaving irrationally, aren't corporations? Surely they can't increase the proportion of their profits paid out to shareholders indefinitely, at least not except at the cost of diminished profit growth? Maybe not. But the hit to profits seems to be a long time coming. Between 1946 and 1983, the proportion of profits paid out ot shareholders averaged 20%, and never rose so high as 30%. Between 1984 and 1999, the proportion of profits paid out to shareholders averaged 71.6%, and never fell so low as 40%. This seems to be a secular shift.

Interestingly, the highest price-payout ratios come in the late '60s, and especially from 1971 to 1973. (Maybe that bull market was a real bubble.) The lowest come in the late '80s. So at least superficially, this measure seems to have some predictive value for stock market returns.

Of course, it makes a difference how the increased payouts to shareholders are being financed. In the '80s, when the ratio of payouts to profits was even higher than it is today, firms reduced their investment. Today, they borrow. I can see reasons why this may be unsustainable, but I still wouldn't call it a bubble.

Other people must have done these calculations. (Dean hadn't, so they can't be too common; he did confirm that I'm not completely confused here.) Robert Shiller's book, which I liked when I read it, mentions the increase in net corporate stock purchases I think twice, once in a footnote. But if this anaysis is correct, his book, with its focus on investor psychology, misses the whole story. If we're seeing irrational exuberance, it's in the boardrooms, not in the chatrooms.


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