Four Ways to Value the Stock Market

Four Ways to Value the Stock Market
Profile photo of David Howden

Analysts and investors were ebullient the other week as the Dow Jones Industrial Average – widely considered as the bell-weather stock index of the United States, and the World – reached its highest level of all time. The intraday high of over 16,601 bested the previous peak from December 2013, and is several orders of magnitude higher than 100 years ago.


Looking at figure 1 we can see the reason why everyone is overjoyed with the stock market’s performance. Over the last 100 years, the Dow has returned 5.4%. This figure includes only the appreciation of stock prices, and thus ignores gains from dividends paid on stocks. It also includes some fairly turbulent periods, such as the Great Depression and the 1970s. Investors had to stay put for a rough ride to realize these returns.

Since the 2009 stock market low, however, the average annual return has been a stellar 13.3%. With such grand performance it’s no wonder everyone wants to get back into stocks.

The period that we are looking at, 1913 to 2014, doesn’t only include a century of mostly uninterrupted stock price increases. It also, coincidentally enough, is the time period over which America’s Federal Reserve has held the reigns of the country’s monetary system. The last 100 years have seen the Fed not only increase the money supply without restraint, but it also has also increased the prices of everything through inflation. (There aren’t any more 5-cent sodas, and a penny stock just ain’t what it used to be.)

In figure 2 we can see how the Dow has performed over the past 100 years in real terms.


Each year inflation causes the dollar to buy a little less than it did the year before. These effects are especially noticeable over long periods, for example, the 100 years that the Fed has existed for. Over this period the average dollar has lost over 95% of its purchasing power. In layman’s terms, that 5-cent bottle of Coke is now worth about a dollar.

Just like bottles of Coke, inflation affects stock market returns, especially over long periods. Since 1913 the inflation-adjusted return of the Dow is only a hair over 2%! This figure might seem low, but at least it is positive. Still, the investor needed to hold his stock portfolio for 100 years to get this return. Most of us (all of us?) are not so lucky.

Over extended periods of time investors lost money in the stock market in real terms. The investor who bought stocks in 1929 had to wait until 1959 to break even! If he didn’t sell his stocks he would have sat on a loss for 30 years. His daughter would have been of prime stock buying age in about 1965. That would have been a pretty poor year to buy a stock, because she would not have broken even on the deal until 1995. Like father like daughter – they both sat on an inflation-adjusted loss for 30 years.

The daughter’s son fared a little better, but not by much. He was in his financial prime in the year 2000. He immediately lost money on his investment in real terms, and wouldn’t break even until last year.

“Stocks for the long run” is the common mantra, but it’s a little more tricky once we adjust for inflation.

In fact, although it is commonly stated that stocks never lose money over a long enough period, these periods might be longer lived than we are. Don’t forget that our Grandfather that bought stocks in 1929 was not clearly out of the red until 1989. That’s right – if he really did buy and hold his shares, he would have still been losing money (in real terms) in 1988, 59 years after his initial investment!

So maybe stocks aren’t such a surefire bet in the long-run, but they are still better than doing nothing. After all, a measly 2% inflation-adjusted return is still better than holding cash. Since the dollar lost 95% of its purchasing power over the past century, someone who just held all his savings as wads of cash under the mattress would have lost about 3% a year on average (the average rate of inflation).

The problem seems to be not so much in guessing how the financial product will perform over the investor’s lifetime, but in how the monetary unit’s value will perform. To illustrate this, let’s look at an alternative monetary unit – an ounce of gold.


Figure 3 illustrates how many ounces of gold it would take to buy a theoretical unit of the Dow. This figure ebbs and flows with regard to stock valuation and the price of gold. In many ways it looks similar to figure 2, the inflation-adjusted Dow, but with two critical differences.

The first difference is that the long-term average annual return is now a measly 1%. Today it costs about 10 ounces of gold to buy the Dow, while in 1913 it took a little under 4. Stocks have outperformed gold over the past century, but not by much.

The second difference is much more important to most investors. This is because most investors don’t have a 100-year time horizon. Over shorter investment periods the Dow has performed horribly compared to gold. If your grandfather sold his gold to buy stocks in 1929, he would still be underwater on the deal. Nor is this poor stock market performance relative to gold a product of cherry picking a peak year in the stock market. If you sold gold and bought stocks during a total of 35 of the past 100 years, you would be losing money today. Flipping a coin to determine whether you buy stocks or gold in any given year would hardly give you a better rate of return.

The stock market hasn’t performed as well as we might think when adjusting for inflation, and its performance is downright poor when we price it in terms of some alternative currency, like gold. Some might point out at this point that gold is an old tired relic, and that it’s not making a comeback as money any time soon. Fair enough, but we can use any number of alternative goods to reprice the Dow to illustrate the point just as well.


In figure 4 I’ve repriced the Dow in terms of bushels of wheat. Gold may have one out of style as money for most, but I’ll bet everyone who is reading this has a diet heavily weighted in this golden grain.

Stock investors are over the moon about the record high Dow and its performance over the past five years, but the picture looks bleak when repriced in terms of wheat. In 2000, you would have needed over 4000 bushels of wheat to buy the Dow. Today you need about half that.

The stock market was remarkably stable in value in terms of wheat for a very long period of time. It had its ups when the market boomed, as in 1929 and 1966. It had its downs when the price of wheat peaked, as in 1918 with the First World War, and the mid-1950s with strong post-War demand. But in the early 1970s something very peculiar happened.

In the early 1970s the Dow took off in terms of wheat and didn’t look back until the collapse of 2000. The early 1970s were not especially unusual years for the wheat market (though with the average wheat price over $4 a bushel in 1974, farmers didn’t see a better year for their crop until 2006). 1974 was a terrible year for the Dow as it lost about half its value, but the uninterrupted rise over the next 26 year period is peculiar by historical standards.

The period corresponds with the longest expansion of credit in the American economy, the date of which commenced with a delinking of the US dollar from gold by Nixon in 1971. This is where nominal values – those denominated in dollars, like the Dow – became unhinged from economic fundamentals (like wheat). Today’s unorthodox monetary policies are causing a similar disconnect. When analysts gush over record stock prices, it is wise to remember that they are speaking in nominal terms. When we reprice stocks in any number of alternative units – be they ounces of gold, inflation-adjusted dollars or bushels of wheat – the story is much bleaker.

One final note. Although it might not seem as sexy as holding stocks like Google and Facebook, a farmer that sold his stocks in 2000 and hoarded his savings in bushels of wheat in the silo would have realized a 5% return on his investment, plus had plenty of food to feed him during the lean years. Now that’s putting your money where your mouth is.

  • W. F. Smith

    Stocks have no "cost of carry" and the dividend defrays the cost of financing their purchase.

    However, both gold and grains need to be stored, insured and financed. Storeage of gold requires that fees be paid to secure insured vault space and the cost of storing grain must include the elevation, storeage and financing of ownership.

    In the particular case of grains, the expense of keeping the inventory in proper condition is a significant annual expense.

    The prices quoted here include neither the positive dividend flow of stocks nor the staggering expense of yearly "carrying costs" in grains.

  • Keith

    Great article, gold and silver are definitely the way to go! Anytime I mention buying gold to my family they think I'm crazy!!

  • Tim Steinkamp

    I came here looking for truth and facts and this statement bothers me.

    "So maybe stocks aren’t such a surefire bet in the long-run, but they are still better than doing nothing. After all, a measly 2% inflation-adjusted return is still better than holding cash. Since the dollar lost 95% of its purchasing power over the past century, someone who just held all his savings as wads of cash under the mattress would have lost about 3% a year on average (the average rate of inflation)."

    How much is a wad of 1913 cash worth today?

    I really don't know the answer but a wad of old cash would not lose 3% a year would it?

    • David Howden

      Tim Steinkamp:

      cash losses value in the sense that it buys less because of inflation. So if you save a dollar this year and prices go up by 3%, next year you´ve really only got $0.97 worth of purchasing power. (Even though you still have one dollar.)

  • aaaplus

    Do the stock price graphs include reinvested dividends? Correct me if I'm wrong, but dividends do make up a large part of stock gains…

    • David Howden


      I ignored dividends just for ease. Once upon a time the dividend yield on the Dow was quite high, reaching double digits in the early 1930s even. It´s been under 5% for 25 years now, and the Fed´s low interest rate policy reducing competition from bonds for yield, it´s only around 2.5% today. You can get a feel for yields over time here:

      In short: it changes the story, though only by a bit.

      • aaaplus

        According to this tool I found: to measure the return on the S&P (I know that your discussing the Dow, but I think this is still applicable,) the S&P returned about 2% (CPI adjusted) a year without reinvested dividends, but returned closer to 6.5% (CPI adjusted) per year, if dividends are assumed to be reinvested (I selected the time period of April 1913 to 2013.) I know adjusting for CPI is not quite measuring the index in gold, but it seems that there would still be a significant difference in returns if reinvested dividends are assumed. Am I missing something? Are there problems in the way the link I provided calculates returns? I'm curious because "stocks for the long run" is such pervasive advise and I'd really like to understand what is really going on.


        • David Howden


          you´re correct, and you could just add the dividend yield to the nominal yields I have in figure 1 to get a good reckoning of total return. Of course, dividend yield is a function of the price you pay and the dividend. So if you happen to buy at a stock market top you´ll always get a low dividend yield. Stocks for the long run is pretty good advice, as long as you don´t buy at the top.

  • bhulihan

    Nice article. Howden is good at plain talking. He reminds me of Hazlitt. Those who took issue with him over his observations about Mt. Gox did not seem to read what he wrote. They made a big deal out of nothing, and he turned out to be correct. Perhaps he was clear and straightforward, and they didn't get it.

  • John Chew

    Excellent post. You drive home the difference between real and nominal returns. Since gold is money that can't be debased, I would choose your Stock/Gold chart. Whenever you use a price index you will have distortions. Stocks/CPI seems useless.

    I will post a link at

Profile photo of David Howden

David Howden is Chair of the Department of Business and Economics, and professor of economics at St. Louis University, at its Madrid Campus, Academic Vice President of the Ludwig von Mises Institute of Canada, and winner of the Mises Institute's Douglas E. French Prize. Send him mail.

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