Updating a post from late 2018 on equity duration. The yield of the market is now down to around 1.5% and inflation expectations are much higher than they were at that time. Hence it is worth revisiting the math of valuing cashflows in a rising rate environment, or at least one in which rates are not relentlessly declining. Updated table below. The conclusion has not changed. If you have a choice of distributable cashflow options, get paid up front. Those distant cashflows take a real beating in any reasonable discounting exercise. In that regard the S&P 500 Index is an outright hostile environment, with a 70-year weighted payback period. Wow. Note that a higher dividend growth rate doesn’t really help make up the difference. In fact, somewhat counterintuitively, it increases the payback period by putting more of the ultimate cashflows in the out years. S&P 500 Index investors, you have a choice.
| Macaulay Duration Matrix for Equity Portfolios | ||||||||||||
| (adjusted May 2021) | ||||||||||||
| The “Dividend” Market | The “Stock” Market | The “Dividend Growth” Market | ||||||||||
| Yield | 4.5% | 4.5% | 4.5% | 1.5% | 1.5% | 1.5% | 3.0% | 3.0% | 3.0% | |||
| Div Growth | 4.0% | 4.5% | 5.0% | 6.0% | 7.0% | 8.0% | 5.5% | 6.0% | 6.5% | |||
| IRR | 8.5% | 9.0% | 9.5% | 7.5% | 8.5% | 9.5% | 8.5% | 9.0% | 9.5% | |||
| Macaulay Duration | 24.11 | 24.22 | 24.33 | 71.67 | 72.33 | 73.00 | 36.17 | 36.33 | 36.50 | |||
| Assumptions: | ||||||||||||
| 1 | Based on cashflows in perpetuity, with no terminal value. | |||||||||||
| 2 | Uses Gordon Constant Growth model, despite simplicity and issues associated with in-perpetuity high dividend growth rates. | |||||||||||