Latest Berkshire Letter Tells Us Dow Is Likely Fairly Valued

Latest Berkshire Letter Tells Us Dow Is Likely Fairly Valued
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On August 2, 2017, the Dow Jones Industrial Average (DJIA) closed at an all-time high of 22,016.24.  Since the financial crisis stock market bottom of March 9, 2009, stocks have risen sharply.  The compounded annual return of the DJIA and the S&P 500 with dividends included has been about 18% over this 8 1/2 year time period.  However, the DJIA had plunged 55 percent from its high on October 9, 2007 as a result of the financial crisis.  Has this sharp rebound exceeded historical annual rates of return?

To answer this question, several studies have indicated that the total return to the stock market has averaged between 9 and 10% compounded per year over many decades.  For example, from the Berkshire Hathaway 2016 Annual Report, the S&P 500 with dividends included has compounded at 9.7% per year over the past 51 years from 1965-2016.

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Instead of comparing the stock market’s return from its generational bottom as a result of the financial crisis of 2007-09, it is more appropriate to examine its performance over a longer time period which both precedes and includes the sharp stock market decline.  If one, therefore, examines the stock market’s performance over the past 10 years from August 2007 until the present time, the returns to the DJIA and S&P 500 are actually slightly below their historical norms.  Over the past 10 years, the DJIA and S&P 500 with dividends included have compounded at about 8 percent per year.  Since this is below the historical average of 9.7% achieved over the past 51 years, and the 9% to 10% returns over many decades, one can conclude that the stock market’s sharp recovery has not resulted in its being overvalued at current levels.

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With corporate earnings growing, interest rates near historical low levels, and the economies in Europe and China recovering, the outlook for stocks continues to be bright.

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David I Kass Clinical Associate Professor, Department of Finance Ph.D., Harvard University Robert H. Smith School of Business 4412 Van Munching Hall University of Maryland College Park, MD 20742-1815 Phone: 301-405-9683 Email: [email protected] (link sends e-mail) Dr. David Kass has published articles in corporate finance, industrial organization, and health economics. He currently teaches Advanced Financial Management and Business Finance, and is the Faculty Champion for the Accelerated Finance Fellows. Prior to joining the faculty of the Smith School in 2004, he held senior positions with the Federal Government (Federal Trade Commission, General Accounting Office, Department of Defense, and the Bureau of Economic Analysis). Dr. Kass has recently appeared on Bloomberg TV, CNBC, PBS Nightly Business Report, Maryland Public Television, Business News Network TV (Canada), Fox TV, American Public Media's Marketplace Radio, and WYPR Radio (Baltimore), and has been quoted on numerous occasions by Bloomberg News and The Wall Street Journal, where he has primarily discussed Warren Buffett and Berkshire Hathaway. He has also launched a Smith School “Warren Buffett” blog. Dr. Kass has accompanied MBA students on trips to Omaha for private meetings with Warren Buffett, and Finance Fellows to Berkshire Hathaway’s annual meetings. He is an officer of the Harvard Business School Club of Washington, DC, and is a member of the investment and budget committees of a local nonprofit organization. Dr. Kass received a Smith School “Top 15% Teaching Award” for the 2009-2010 academic year.
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