A century of market history
How Graham judged whether the whole market was cheap or dear, and why he never trusted the past to repeat.
FinanceGraham ch. 3About 5 min: 3 reading, 2 practiceUpdated
General education, not financial advice.
- Calculate an earnings yield from a P/E ratio
- Compare the earnings yield of stocks with the yield on bonds, as Graham did
- Explain why extrapolating past returns is dangerous
The Intelligent Investor: Benjamin Graham's ideas: lesson 3 of 24
- Graham ch. 1
- Investment versus speculation 4 min
- Graham ch. 2
- Inflation and the investor 4 min
- Graham ch. 3
- A century of market history 5 min
- Graham ch. 4
- The defensive investor's portfolio 4 min
- Graham ch. 5
- Defensive investors and stocks 4 min
- Graham ch. 6
- What the enterprising investor avoids 4 min
- Graham ch. 7
- What the enterprising investor does 5 min
- Graham ch. 8
- Mr. Market 5 min
- Living with fluctuations 5 min
- Graham ch. 9
- Investing in funds 5 min
- Graham ch. 10
- The investor and his advisers 4 min
- Graham ch. 11
- Security analysis for the lay investor 4 min
- Graham ch. 12
- Per-share earnings and their traps 4 min
- Graham ch. 13
- Comparing four companies 4 min
- Graham ch. 14
- The defensive investor's screen 4 min
- Graham ch. 15
- The enterprising investor's screen 7 min
- Graham ch. 16
- Convertibles and warrants 6 min
- Graham ch. 17
- Four extreme case histories 7 min
- Graham ch. 18
- Eight pairs of companies 7 min
- Graham ch. 19
- Shareholders, managements and dividends 5 min
- Graham ch. 20
- Margin of safety (1): the idea 5 min
- Margin of safety (2): in practice 7 min
- Graham appendix 1
- The superinvestors of Graham-and-Doddsville 6 min
- Graham postscript
- Graham today 7 min
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Pairs with Graham, The Intelligent Investor, revised edition with commentary by Jason Zweig (HarperBusiness, 2003), chapter 3, "A Century of Stock-Market History"
What it is
In chapter 3 Graham reviews a century of U.S. stock prices, earnings and dividends (1871–1971) and asks: is the market today too high for a careful investor?
His main tool is to compare what stocks earn with what bonds pay:
- Earnings yield = earnings ÷ price, the P/E ratio turned upside down. A P/E of 18 is an earnings yield of 1 ÷ 18 ≈ 5.6%.
- Compare it with the yield on high-grade bonds.
Graham found the comparison had turned against stocks: in 1948 stocks' dividends yielded about twice as much as bonds; by early 1972 bonds yielded about twice as much as stocks' dividends. He judged the market of early 1972 (the Dow at about 900) no bargain, and advised caution.
Quick check
Tap an answer to check it.
A market trades at a P/E of 20. What is its earnings yield?
- Earnings yield is 1 ÷ P/E
Show answer
5%. 1 ÷ 20 = 0.05.
Why it matters
Zweig notes that the bear market of 1973–1974, starting about a year after Graham wrote, took 37% off U.S. stocks. More important than the call is Graham's warning: never forecast the future only by extending the past. Zweig shows the same mistake in 1999, when books predicted the Dow would reach 36,000, 40,000 or even 100,000 because stocks had "always" done well.
Worked example
Two moments for the same imaginary market:
| Year A | Year B | |
|---|---|---|
| P/E ratio | 10 | 25 |
| Earnings yield | 10% | 4% |
| High-grade bond yield | 5% | 6% |
| Earnings yield ÷ bond yield | 2.0 | 0.67 |
In Year A, stocks earn twice what bonds pay; in Year B, less than bonds. Graham's test says Year B calls for much more caution, even though nobody can say when, or whether, prices will fall.
Common mistake
"Stocks have returned 7% after inflation for two centuries, so I'll get 7% from here." Graham's point is that the price you pay changes the return you can expect: the same companies bought at a higher P/E leave less room for return, and for error.
Key terms
- earnings yield
- earnings ÷ price; the P/E ratio upside down
- bond yield
- the yearly return on a bond at its current price
- bear market
- a large, lasting fall in prices
- extrapolation
- assuming a past trend will simply continue
Practise the key terms
Tap a card to turn it over. 4 cards.
| Front | Back |
|---|---|
| earnings yield | earnings ÷ price; the P/E ratio upside down |
| bond yield | the yearly return on a bond at its current price |
| bear market | a large, lasting fall in prices |
| extrapolation | assuming a past trend will simply continue |
Practice
Work it through
The market's P/E is 16 and high-grade bonds yield 7%.
- 1 ÷ 16 × 100
- 6.25 ÷ 7
Quick quiz
Tap an answer to check it.
Graham compared the market's earnings yield with…
- He warned against relying on past returns
Show answer
the yield on high-grade bonds. Stocks versus the safe alternative.
What is the main lesson Zweig draws from this chapter?
- Graham admitted an earlier cautious call came well before a further large rise; Zweig's point is about extrapolation, not prediction
Show answer
Never forecast the future only by extending the past. Extrapolation fails; the price you pay matters.
The other view
Later research supports part of Graham's idea and limits the rest. Studies of market-wide valuation, such as Campbell and Shiller's work on price-to-earnings ratios, find that high valuations have tended to be followed by lower returns over the next ten years or so, on average. But valuation is a poor guide to timing: an expensive market can stay expensive, or get more so, for years. Graham himself admitted that one of his earlier cautious calls came well before a further large rise.
Last checked: 27 October 2026.
In short
- Earnings yield = 1 ÷ P/E.
- Graham compared stocks' yields with bond yields to judge whether the market was high.
- In early 1972 he judged it no bargain; the 1973–74 fall followed.
- Never assume past returns will simply continue: the price you pay changes what you can expect.
Mastery check
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Check yourself
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What is the earnings yield at a P/E of 25?
Show answer
4%.
In 1948 stocks yielded about twice as much as bonds. What was the position in early 1972?
Show answer
The reverse: bonds yielded about twice as much as stocks' dividends.
Why can't valuation tell you when a market will fall?
Show answer
An expensive market can stay expensive, or get more so, for years; valuation says more about long-run returns than timing.
Further reading
- Benjamin Graham, The Intelligent Investor, revised edition with commentary by Jason Zweig (HarperBusiness, 2003), chapter 3.
- John Y. Campbell and Robert J. Shiller, "Valuation Ratios and the Long-Run Stock Market Outlook", Journal of Portfolio Management 24(2), 1998, 11–26.
- On this site: Where stock returns come from.
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