This type of valuation technique can be applied to the future flow of Earnings just as well as Dividends. However, the contrasting results are intriguing.

As of Dec 31, 2004 the S&P 500 had "core" earnings of $53.80 per share and paid a dividend of $19.44. Let's use 30 years as the holding period of our investment. Next, we need some estimate of the future rate of growth of earnings and dividends. For the last 15 years operating earning have grown at a 6.77% rate and dividends have grown at a 4.0% rate. Let's use those for starters. Using those growth rates, "core" earnings 30 years from now on Dec 31, 2033 will amount to $368.68 and dividends will be $65.37.

Next problem is to determine how we are going to capitalize these flows. Here is where examining Earnings vs. Dividends begins to produce curiously divergent results. The most common expression for earnings capitalization is, of course, the Price to Earnings ratio (P/E). At 1180 on the S&P the P/E on the 2004 core earnings is about 22 times earnings. The most common expression of Dividend capitalization is the Dividend Yield. At 1180 the 2004 Dividend Yield is about 1.7%. The inverse of the Dividend Yield or Price/Dividend (P/D) would thus be about 60 times dividends. So, obviously the markets view earnings and dividends in a different light. Earnings are not dividends and dividends are not earnings. We value Earnings and Dividends differently.

Using a P/E of 20, our expected Dec 31, 2033 core Earnings of $368.68 would fetch a price of 7,373.57. What's that worth to us today? Depends on your personal capitalization rate. What kind of return do we demand to induce us to own this type of risky asset? This is the key to the whole thing. For argument's sake let's just say we need to get an annualized return of 12% to justify an investment in the S&P 500. Ok, so that 7,373.57 on Dec 31, 2033 is worth 275.65 to us today. How about the value of the future flow of Earnings? 30 years of Earnings growth starting from a base of $53.80 and growing 6.77% per year at a 12% capitalization rate is worth 1,055.08 to us today. So based on our inputs and our return requirements, we should be willing to pay no more than 1,330.73 for the S&P today.

Using a Dividend Yield of 1.7 % our Dec 31, 2003 expected Dividend of $65.37 yields a market value of 3,845.40. At a 12 % capitalization rate that 3,845.40 is worth 143.75 today. The Dividend flow for 30 years starting from a base of $19.44 and growing at 4.0% annually is worth 240.73 today. This yields a DDM intrinsic value of the S&P 500 of 384.48 today.

Big difference in intrinsic value whether your valuing earnings or dividends. Why? Look at the growth rates. Dividends aren't as large as earnings to begin with and aren't projected to grow nearly as fast as earnings. At comparable capitalization rates, to get that DDM model to value at something near the Earnings model we would have to grow dividends over the next 30 years at a rate which we have never approached in history. So, earnings and dividends warrant a different cap rate expectation.