The Wall Street Waltz: 90 Visual Perspectives, Illustrated Lessons From Financial Cycles and Trends, Revised and Updated Edition

Chart 5

Price/Dividend Ratios Provide Long-Term Vision

This chart shows the single most powerful indicator of long-term stock market direction I've seen. It's so simple, but inexplicably powerful. It doesn't say if the market is headed up or down right now, but its predictive record of what's a few years down the pike is stunning. Chart A is the background—the Dow Jones Industrials since 1920. The solid line delineates the Dow's latest 12-month dividends multiplied by a price/dividend ratio of 22.7. Notice that the line follows the Dow quite closely. This shows that for the past 65 years, the Dow Jones Industrials sold for an average of roughly 22.7 times their dividends.

Chart B holds the predictive power. It illustrates the Dow's price/dividend ratio for the same 65-year period. It is merely the price of the Dow divided by its last four total quarterly dividends. If the Dow is at 1,800, and the Dow stocks paid a total of $90 of dividends in the last year, then the price/dividend ratio is exactly 20. (The total Dow dividends appear regularly in Barron's if you want to track this yourself.)

There are three horizontal dotted lines on this graph. The middle one is the aforementioned 22.7 average. The high and low dotted lines are the most telling market forecasters. The lower line represents 17 times dividends. When the market has sold close to or below 17 times dividends, a major bull market has almost always started soon. By contrast, the top line represents 28 times the market's ...