V.6:10 (389-389): Price/dividends ratio by Arthur Merrill

V.6:10 (389-389): Price/dividends ratio by Arthur Merrill
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Price/dividends ratio by Arthur Merrill

An indicator that was shouting warnings before the stock market crash last year was the price/dividends ratio. This indicator is a measure of expensiveness. It reports the current price of enough stock to yield $1 in dividends. It's the inverse of stock yield.

Note Figure 1 which is based on the Dow Jones Industrial Average (DJIA). All price swings of less than 20% have been ignored, or filtered out. The price/dividends ratio was then calculated at each price turning point by dividing the DJIA by the dividends in the preceding four quarters. The chart extends back to the beginning of the DJIA dividend reports in 1929. (Unfortunately, the reports include stock dividends, so there may be some error from that practice.)

Note that the indicator corrects for inflation. Both the numerator and denominator of the ratio are in dollars, so the effect of inflation on the value of the dollar cancels out.

The curve also takes wide swings. Investors in 1932 were willing to part with their stock at a price less than 10 times the dividends. Then there were years in which they had to pay more than 30 times the dividends.

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