What Drives Stock Returns?
Hint: It’s more than just company profits.


We’re told over and over that growth in corporate earnings drives stock market returns. If that’s the case, what has been going on lately? In 2019, Standard & Poor’s 500-stock index posted a total return of 32%, but corporate earnings barely moved. In 2018, with corporate profits solidly up, the market surrendered 4.4%. The truth is, earnings are only part of the picture when it comes to stock market returns. Understanding the whole mosaic can give you insight on how to manage your portfolio.
You can divide stock returns into three primary drivers, which can work in concert or at odds: earnings growth, valuation and dividends. In a vacuum, earnings growth is the easiest to understand. Say a stock costs $100 per share and posts earnings of $10 per share. If earnings grow by 5%, to $10.50, then the stock price should grow by a commensurate 5%, to $105, producing a 5% return.
But stock prices reflect what investors expect in the future. Their confidence or negativity about a stock’s potential is expressed in its valuation, commonly represented by a measure such as the price-earnings ratio. If investors are bullish on a stock, they’ll bid up the price, thus “expanding” the stock’s price-earnings multiple and boosting return.

Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Say the $100 stock with $10 in earnings has a P/E of 10. Should confident investors bid the price up to 12 times earnings, the stock would now trade at $120, a 20% return. In 2019, 29 percentage points of the S&P 500’s 32% return came from valuation expansion. “Valuation expansion last year was in anticipation of earnings growth this year,” says analyst Willie Delwiche, at investment firm Baird.
Understanding where the market’s valuation stands compared with historical averages can give investors a sense of market risk, says Delwiche, because valuations tend to revert to mean levels over time. At 18 times expected year-ahead earnings, the S&P 500 trades above the 10-year average of 15. That doesn’t mean prices will come down imminently, Delwiche says, but it could signify that investors should explore less-volatile pockets of the market or consider investing overseas, where stocks are trading closer to historical norms.
Count on dividends. Income investors know the power of the third major driver of total returns: dividends. Since 1955, earnings growth has contributed 63% of the S&P 500’s total annual return, on average, followed by dividend payments (28%) and expansions or contractions in valuation (9%), according to Calamos Wealth Management.
Of those factors, dividends are the least volatile and don’t ever detract from the market’s return. As a result, reinvested dividends have an outsize impact on the market’s return over time. From the end of 1970 through 2019, 78% of the total return of the S&P 500 came from the compound growth of reinvested dividends, according to analysts at the Hartford Funds. The message is clear, says CFRA investment chief Sam Stovall: “Dividends reward the buy-and-hold investor.”
What will drive returns in 2020? Calamos Wealth Management chief investment officer Reed Murphy believes the baseline case is for valuations to hold relatively steady and for earnings growth for companies in the S&P 500 to come in below current estimates of 9%-plus. He suggests the S&P 500 is likely to return 7% to 8% in 2020, including a 1.9% dividend yield.
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.

Ryan joined Kiplinger in the fall of 2013. He wrote and fact-checked stories that appeared in Kiplinger's Personal Finance magazine and on Kiplinger.com. He previously interned for the CBS Evening News investigative team and worked as a copy editor and features columnist at the GW Hatchet. He holds a BA in English and creative writing from George Washington University.
-
Ford Warns $3 Billion Tariff Bill Will Cut Profits and Pressure Prices in 2025
Ford now expects a $3 billion tariff hit this year — pushing up costs on parts, altering vehicle pricing and narrowing dealer discounts even as sales stay strong.
-
What Trump's EU Trade Deal Means for Your Wallet
Trump's trade deal with the EU averted the worst case scenario, but US consumers might still see price hikes on some key goods.
-
Stocks Can't Hold Meta, Microsoft Gains: Stock Market Today
The main indexes all opened higher Thursday on impressive Big Tech earnings, but momentum faded into the close.
-
Stocks Are Up and Down on Fed Day: Stock Market Today
In another sign of changing times, JPMorgan has partnered with Coinbase to enable cryptocurrency purchases with credit cards.
-
UnitedHealth Stock Drags on Dow: Stock Market Today
Corporate earnings have dominated Wall Street's attention this week, but that changes on Wednesday.
-
Stocks Close Mixed to Start Fed Week: Stock Market Today
News of an EU-U.S. trade deal was met with muted reaction from market participants who are looking ahead to a jam-packed week.
-
Stocks Rise After Trump-Powell Fed Tour: Stock Market Today
Nvidia hit a new all-time high intraday, but another renowned semiconductor name and some less iconic stocks were bigger movers Friday.
-
Dow Bleeds Red Due to Big Blue: Stock Market Today
Six of the official GICS sectors were in the green, led by communications services, technology and energy stocks.
-
Dow Jones Industrial Average Nears New Highs: Stock Market Today
The successor to the first stock market index is getting up there with the S&P 500 and the Nasdaq Composite in all-time-high territory.
-
Dow Leads as Merck, Amgen Gain: Stock Market Today
Second-quarter earnings season remained top of mind Tuesday, with Coca-Cola and GM among those reporting.