Morningstar Magazine - October/November 2017 - 51

EXHIBIT 4

Similar Long-Term Prediction Power Since 1881, CAPE and CATY each had an R-squared of 18%, meaning both measures
explained close to one fifth in the variability of future five-year returns over the time period.
1881-2016: 1/CAPE

5-Year Real Forward Returns (Annualized)

1881-2016: CATY

5-Year Real Forward Returns (Annualized)

30
%

30
%

15

15

0

0

R2=0.18114

R2=0.18137

-15
0%
1/CAPE

5

10

15

20

25

-15
0%
CATY

Source: Morningstar.

2

4

6

8

10

12

14

Source: Morningstar.

EXHIBIT 5

More-Recent History But since 1970, CATY significantly outperformed, explaining 24% of the variability of forward returns, while
the CAPE ratio only explained 9%.
1970-2016: 1/CAPE

5-Year Real Forward Returns (Annualized)

1970-2016: CATY

5-Year Real Forward Returns (Annualized)

30
%

30
%

15

15

0

0

R2=0.08758

R2=0.2364

-15
0%
1/CAPE

2

4

6

8

10

Source: Morningstar.

performed significantly better more recently.
A key advantage of CATY is the fact that it relies on
total payouts, the cash flows distributed to
shareholders. It is, therefore, less prone to changes
in accounting standards or the discretion of
accountants. Earnings are just a means to an end,
as John Burr Williams pointed out, while the intrinsic value of an asset is based on the net present
value of its cash flows. CATY is a useful tool
for investors looking to gauge the valuation of the
stock market in a long-run historical context. K
Philip U. Straehl is head of capital markets and asset
allocation with Morningstar Investment Management, LLC.

12

14

-15
0%
CATY

1

2

3

4

5

6

7

Source: Morningstar.

Roger G. Ibbotson is Professor in the Practice Emeritus
of Finance with the Yale School of Management
and chairman and chief investment officer of Zebra
Capital Management.
References
Boudoukh, J., Michaely, R., Richardson, M., & Roberts,
M.R. 2007. "On the Importance of Measuring Payout Yield:
Implications for Empirical Asset Pricing." The Journal of
Finance, Vol. 62, pp. 877-915.
Campbell, J.Y., & Shiller, R.J. 1998. "Valuation Ratios and
the Long-Run Stock Market Outlook." Journal of Portfolio
Management, Vol. 24, No. 2 (Winter), pp. 11-26.
Dichev, I., Graham, J., Harvey, C.R., & Rajgopal, S. 2016.
"The Misrepresentation of Earnings." Financial Analysts

Journal, Vol. 72, No. 1.
Grullon, G., & Michaely, R. 2002. "Dividends, Share
Repurchases, and the Substitution Hypothesis." Journal of
Finance, Vol. 57, pp. 1649-1684.
Miller, M.H., & Modigliani, F. 1961. "Dividend Policy,
Growth, and the Valuation of Shares." The Journal of
Business, Vol. 34, No. 4 (October 1961), pp. 411-433.
Siegel, J.J., 2016. "The Shiller CAPE Ratio: A New Look."
Financial Analysts Journal, Vol. 72, No. 3.
Straehl, P.U., & Ibbotson, R.G. 2017. "The Long-Run Drivers
of Stock Returns: Total Payouts and the Real Economy."
Financial Analysts Journal, Vol. 73, No. 3.

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