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By Gerald Sirkin
PROFESSOR OF ECONOMICS
CITY COLLEGE

CITYUNIVERSITYOF NEW YORK

The Stock Market of 1929
Revisited: A Note
€ Applying a formulation devised by Burton G. Malkiel to stock prices
prior to the market crash of 1929, this study finds that descriptions of the
period as a "speculative orgy" are misleading.

Few economists have questioned and none has dented the
dogma that the prices of common stocks in the United States in
1929 were the product of a "speculative orgy" in a "time of madness." 1 Shortly after the stock market crash, Irving Fisher did
question the speculative madness view, in an article and in a book,2
but his arguments quickly dropped from sight leaving no mark.
Several others have taken positions similar to Fisher's,3 but also
apparently without effect on the general consciousness.4
Fisher's position was that the growth of corporate earnings during
the 1920s was not a transitory phenomenon but a durable result of
economic development, that the continuation of such growth was a
reasonable expectation, and that the increased valuation of stocks
based on increased expectations of growth represented rational investor behavior. Stock prices would have risen nearly as much, he
believed, even if there had been no "overextension of credit" for
stock purchases. He judged that "between two-thirds and threefourths of the rise in the stock market between 1926 and September,
1929, was justified" 5 by prospective earnings and that the crash
could be explained by "the unsound financing of sound prospects."6
Business History Review, Vol. XLIX, No, 2 (Summer, 1975). Copyright © The
President and Fellows of Harvard College.
1
See John Kenneth Galbraith, The Great Crash: 1929 (Boston, 1961), xx, xxi.
2
Irving Fisher, "The Stock Market Panic in 1929" American Statistical Association,
Proceedings, March, 1930, Supplement, N.S. No. 169A, pp. 93-96; The Stock Market
Crash - and After (New York. 1930).
3
Robert Sobel, The Great Bull Market: Wall Street in the 1920's (New York, 1968);
Lester V. Chandler, America's Greatest Depression, 1929-1941 (New York, 1970).
4
Leading text books still speak of A "wild 'bull' market" based only on self-induced
speculative expectations (Paul A. Samuelson, Economics, 9th ed.. New York, 1973, p.
74); and of "the speculative boom of 1928-29, when speculative activity reached heights
completely out of touch with the actual profit possibilities or the general level of business
activity." (George L. Bach, Economics, Englewood Cliffs. New Jersey, 1974, p. 125.)
5
Fisher, "The Stock Market Panic in 1929," 94.
6
lbid., 96.




Unfortunately, the Fisher position was not backed up by any
rigorous analysis of stock values, which may account for the scant
attention paid to it and for the dominance of the "speculative madness" school of thought
Since Fisher's time, some progress has been made in the theory
of stock values as affected by expectations of the growth of earnings.
I propose to use this theory to evaluate the behavior of the stock
market in 1929, applying the formulation devised by Burton G.
Malkiel.7
Assume that the earnings per share of a stock are expected to
grow at an above normal rate, g, for n years, after which earnings
are expected to grow at a normal rate. Assume also a given ratio
of dividends to earnings, d, and a rate of return, r, necessary to
induce investors to hold the stock. From these data, the appropriate
price, P, of the stock (the price at which the stock can be purchased
to yield the required rate of return, r) can be calculated. This price,
converted to the form of a price-earnings ratio by dividing by the
current earnings per share, E, is given by the following equation:

where is the price-earnings ratio that will be appropriate for the
stock in its normal-growth phase.
The calculated price-earnings ratio thus depends on five variables:
the expected growth rate during the rapid-growth phase, the expected length of the rapid-growth phase, the required rate of return,
the dividend-earnings ratio, and the normal price-earnings ratio.
Inasmuch as we cannot assert what would have been "reasonable"
figures for all of these variables for any stock in 1929, we cannot
calculate exactly the "reasonable" price-earnings ratios. But we
can, with the aid of certain calculations, show the expectations implied by the price-earnings ratios that existed in 1929 and consider
whether these implied expectations fall within a reasonable range.
The sample of stocks to be examined is the group in the DowJones Industrials average in 1929. This average increased, from its
high point in 1924 to its high point in 1929, by 216 per cent. To
check whether the Dow-Jones stocks were representative of the
peak price-earnings ratios prevailing in 1929, I have calculated comparable ratios for a random sample of thirty stocks traded on the
New York Stock Exchange in 1929, omitting those without positive
earnings. The price-earnings ratios of this sample range from 6.2
7
Bunton G. Malkiel. "Equity Yields, Growth, and the Structure of Share Prices."
American Economic Review, Vol. 53, No. 5 (December, 1963), 1004-1031.

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to 40.4, with a mean of 19.6 and a median of 16.3, The priceearnings ratios of this sample are thus substantially lower than the
Dow-Jones sample, which ranged from 11.3 to 65.2, with a mean of
24.3 and a median of 20,4; but the average quality of the stocks of
the random sample is also lower than the quality of those in the
Dow-Jones Industrials. At any rate, the use of the Dow-Jones Industrials does not appear to bias the study in the direction of understating the prevailing price-earnings ratios.
Table I shows the peak price-earnings ratios of twenty-nine
stocks. The question to be answered is whether or not these ratios
imply such exorbitant expectations about the rate, g, and duration,
n, of the growth of earnings as to warrant the orthodox view that
the speculation was irrational.
To isolate the implications with respect to g and n, some plausible
values for r, d, and will have to be assumed. With respect to r, a
rate two or three percentage points over the rate on corporate bonds
seems reasonable. Yields on good-to-high quality corporate bonds
during 1929 ran 5 per cent to 6 per cent, suggesting an r of between
7 per cent and 9 per cent. Let us say 9 per cent, to be conservative.
The average dividend-earnings ratio of the twenty-nine stocks
in Table I was .53 in 1929. For all corporations in 1929, the ratio of
dividends to net earnings was .67. An expected d of .5 during the
rapid-growth phase does not seem an excessive assumption for the
purpose of these calculations.
The normal price-earnings ratio,
depends on
and - the
rate of return, dividend ratio, and growth rate that will pertain to
the normal-growth phase.8 Let us initially assume that is the same
as r, 9 per cent. Then for various combinations of d and g can be
calculated:

d\g
.5
.6
.7
.8
.9

1.0

5.6
6.7
7.8
8.9
10.0
11.1

1%
6.3
7.5
8.8
10.0
11.3
12.5

4%
7.1
8.6
10.0
11.4
12.9
14.3

8.3
10.0
11.7
13.3
15.0
16.7

5%

10.0
12.0
14.0
16.0
18.0
20.0

12.5
15.0
17.5
20.0
22.5
25.0

8
The rate of return,
consists of the dividend yield,
and the rate of growth of
the price of the stock. With a fixed P/E, the growth rate of P will equal
the growth
rate of E.
t h e r e f o r e , ( W h a t if = 0?
refers to a

steady-state dividend ratio — one that will continue permanently. A stock that will never
pay a dividend will presumably have a zero price, no matter what the growth of earnings.)




STOCK MARKET OF 1929

225

TABLE I
DOW-JONES INDUSTRIALS *
PRICE-EARNINGS RATIOS AND GROWTH RATES OF EARNINGS

Corporation

Price/

Earnings
1929**

Annual Percent Change,
EarningsPerShare
1924-1929

1925-1929

Allied Chemical
American Can
American Smelting & Refining

28.2
23.0
13.0

11.7
9.3
19.0

9.0
-0,4
9.4

American Sugar
American Tobacco "B"
Atlantic Refining

11.3
20.4
12.1

-8.0
5.1
30.4

18.0
3.4
16.5

Bethlehem Steel
Chrysler
General Electric

12.8
27.3
44.9

41.2
40.1
11.2

15.8
-2.4
11.8

General Motors
General Railway Signal
Goodrich

16.9
15.3
21.7

29.9
20.1
-9.0

7.9
12.0
-20.7

International Harvester
International Nickel of Canada
Mack Truck
Nash Motors
National Cash Register "A"

17.4
49.2
12.6
18.0
21.2

17.3
49.4
-4.7
17.1
2.3

13.9
18.4
-6.4
3.4
-1.2

North American Corp.
Paramount-Famous
Postum (General Foods)

65.2
13.1
22.2

8.8
-2.5
9.3

8.9
4.9
5.0

Radio Corp. of America
Sears, Roebuck
Standard Oil, N.J.

60.0
27.3
17.4

22.1
13.8
7.6

16.2
8.9
0.0

Texas Corp.
Texas Gulf Sulphur
Union Carbide

14.1
133
35.5

4.0
27.6
13.5

-3.4
23.4
9.4

U.S. Steel
Westinghouse Electric
Woolworth

13.1
28.8
28.3

12.5
8.4
2.8

10.5
9.6

24.3
20.4

14.1
11.7

8.0
8.9

Mean
Median

* Curtiss-Wright, which had an earnings deficit in 1929, has been omitted, as its priceearnings ratio cannot be calculated.
** Ratio of the highest price in 1929 to earnings per share in 1929.

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The lower and higher of these values of can be eliminated since
it is improbable that a firm would normally reinvest a very high
proportion of earnings with little or no expected growth, or would
reinvest a very low proportion with significant prospects of growth.
The relevant values of therefore, lie in a band running diagonally
from the lower left to the upper right of the table, i.e., values between 10 and 15.
The narrowing of the plausible range of can be supported by
another approach. In the normal-growth phase, the rate of return
on equity is likely to tend toward some competitive equilibrium,
which the firm will attempt to maintain by its reinvestment policy.
To maintain that equilibrium of earnings/equity, earnings and
equity would have to grow at the same rate. Assuming such a
policy, we can make a calculation of plausible values of 9 With
an of 9 per cent, and earnings/equity ratios of 10 per cent to 12 per
cent (the predominant range over the long run in manufacturing),
the calculated values of for from .5 to 1, run from 11.1 to 16.7.
An argument can be made for somewhat higher values of than
those obtained by the above calculations. If 9 per cent is a reasonable assumption for r, then might well be assumed to be lower.
Greater risk is attached to stocks during their rapid-growth phase
than during their normal-growth phase, because of the greater uncertainty about rapid growth. Consequently, in the normal-growth
phase, a lower acceptable rate of return might be assumed. If is
set at 8 per cent, then the implied by a constant earnings/equity
ratio runs from 12.5 to 25.
Nevertheless, despite the possibility of justifying those higher
estimates of
it seems preferable to provide a relatively strict test
of speculative behavior by choosing moderate values for
I shall,
therefore, in the calculations that follow, use values of 12 and 15
for as the lower and upper levels of reasonable estimates.
In order to evaluate the price-earnings ratios of the individual
stocks, it would be necessary to estimate g and n for each stock.
But it is futile to conjecture now about what expectations of growth
for each corporation would have been reasonable in 1929. The only
feasible approach is to attempt some overall judgments on the
stocks as a group.
9
The increments to equity will be
assuming equity increases only by reinvestment of earnings, and the rate of growth of equity, Q, will be
_
By the assumption that E and Q grow at the same rate.
_
From footnote 8,
. Substituting for
When assumed

values for

and E/Q are inserted,




can bo calculated for every

STOCK MARKET OF 1929

227

Table I shows the price-earnings ratios of twenty-nine stocks, and
the growth rates of earnings for these companies, for the two
periods 1924-1929 and 1925-1929. Since 1924 was a year of mild
recession and earnings were below "normal," the use of the 1924
base exaggerates the growth rate. But whichever period is used,
one conclusion from these figures seems clear: The growth expectations underlying the price-earnings ratios of the individual stocks
were not simple projections of each company's own record in the
previous four or five years. The coefficient of rank correlation between price-earnings ratios and previous growth rates is close to
zero (.06 for 1924-1929 growth rates, and - . 0 7 for 1925-1929
growth rates). The high average growth rates may have influenced
expectations, but individual company experience evidently did not.
Rather than examine individual stocks, therefore, let us consider
the answer to some general questions.
1. What g and n would have justified the median price-earnings
ratio of 20.4 in Table I?
With = 12, the following annual growth rates would have been
required:
17% for 5 years
14% for 7 years
11% for 10 years
With
quired:

= 15, the following growth rates would have been re12% for 5 years
11% for 7 years
9% for 10 years

Obviously, the justification of a price-earnings ratio of 20.4 requires extremely optimistic growth expectations. If the median
growth rate of 1925-1929, 8.9 per cent, is taken as a reference
point, only a ten-year duration of that rate, with = 15, would have
warranted such a price-earnings ratio.
2. What g and n would have been required to justify the actual
median price-earnings ratio at the peak of the market?
The procedure of taking the highest price reached by each stock
during the year, as in Table I, naturally gives an exaggerated impression of the height reached by the group at any point of time.
If, instead, we take the closing prices as of September 2, 1929,
approximately the peak of the market, we find for these twentynine stocks a median P/E of 15.1 and a mean P/E of 21.6.
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TABLE II
DISTRIBUTIONS OF PRICE-EARNINGS RATIOS

P/E

<10
10 to <12
12 to <15
15 to <20
20 to <25
25 to <30
30 +
mean P/E
median P/E

Actual Distribution
0
1

Calculated Distribution
= 12
=15
8
4
7

2

5
5

7
2
1

11
5
3

5
24.3
20.4

0
14.0
14.5

8
5

3
4

1
18.0
18.4

To justify the median P/E of 15, the following growth rates would
have been required:
With = 12, the required growth rates are:
10% for 5 years
9% for 7 years
8% for 10 years
With = 15, the required growth rate is 6 per cent for 5, 7, or
10 years.
The actual median P/E could have been justified by growth rates
not very different from the median growth rate of 1925-1929, on the
assumption of = 12, while with = 15, a comparatively moderate
growth rate would have been sufficient.
3. If the median growth rate of 8.9 per cent had been expected to
continue for five years, and the expected distribution of growth
rates about the median had been the same as in 1925-1929, what
distribution of price-earnings ratios would have been justified?
Table II compares the actual distribution from Table I with the
calculated distributions, based on = 12 and = 15.
The means and medians indicate that the peak prices of the
stocks were considerably in excess of what could be justified by a
growth rate of 8.9 per cent for so short a period as five years. The
distributions, on the other hand, show that both the actual and
calculated distributions are bunched in the 12 to 20 range. At the
low end of the distribution, the difference between actual and
calculated can be attributed mainly to the seven negative growth
rates (1925-1929) in Table I. It is improbable that, in a period of
generally strong growth, investors would expect persistently de-




STOCK MARKET OF 1929

229

dining earnings among a group of high-grade stocks. The differences at the upper end of the distribution are more pertinent to
the question of speculative behavior. A few extreme cases account
for the chief differences at the upper end between the actual distribution and the calculated distributions. If the calculated distributions are roughly realistic, they suggest that conspicuously unsound
speculation was not general, but was concentrated in a small proportion of stocks.
4. Was there any ground for expecting high growth of earnings
to continue for five years or more?
The optimism in 1929 of many commentators on business prospects, the idea that the economy had entered a "new era" of
development, is usually attributed to the experience of eight years
of expansion uninterrupted by any serious cyclical disturbance. But
this period of comparative stability, free of monetary disruptions,
may have permitted only a belated recognition of a more fundamental change that had occurred in the economy. Modern statistical
analysis lends support to the notion of a new phase of technological
progress that was sensed in the 1920s.
A recent examination of U.S. growth data since 1800 finds a major
change in the nature of the growth process, beginning early in the
twentieth century.10 The data from 1800 to 1905 associate growth
primarily with the growth of labor and capital inputs, with only a
minor contribution from the improvement of total factor productivity
(the residual growth after deducting the contributions of additional
labor and capital). The data from 1905 to 1927 and from 1927 to
1967 show a sharp drop in the rate of growth of capital and a sharp
jump in the rate of increase of total factor productivity. These new
trends can be explained by some combination of technological improvement tending to increase the rise of the productivity of capital
together with a higher rate of investment in "unconventional
capital" (knowledge and human skills). Whatever the explanation
for the new trends, their outcome would be acceleration in the rate
of growth of corporate earnings. It thus appears that the expectations of faster growth of earnings in a 'new era' differing radically
from the long upward swing of progress that has characterized the
industrial revolution,"11 had a real basis — a major shift in the
underlying components of the growth process.
10
Moses Abramovitz and Paul A. David, "Reinterpreting Economic Growth: Parables
and 11
Realities," American Economic Review, LXII, No. 2 (May, 1973), 428-439.
Fisher. The Stock Market Crash and After, 100. Fisher described the claim of a
"new era" as "exaggerated," but he believed that the "tempo" of invention, scientific
research, and business activity had increased.

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BUSINESS HISTORY REVIEW




From these questions and answers, some broad conclusions can
be drawn about the rationality or irrationality of the stock-market
speculation in 1929.
1. While there were good grounds for expecting that the comparatively high growth rates of earnings experienced in the 1920s
would continue for some limited number of years, these expectations could not reasonably have justified the peak price-earnings
ratios of the Dow-Jones Industrials, taken as a group. The median
growth rate of the previous four years could have justified (if one
accepts the assumptions of the calculations), a median price-earnings ratio of between 14.5 and 18.4) while the actual median of the
peak price-earnings ratios was 20.4.
2. On the other hand, an examination of the peak of the market,
rather than the individual peaks, indicates that the median priceearnings ratio at the market peak could have been justified by earnings expectations that were not patently unreasonable.
3. The distribution of the peak price-earnings ratios, when compared to distributions calculated on the assumption of a short rapidgrowth phase, suggest that the marked over-valuation of stocks
was not general, but was concentrated in a fraction — in the neighborhood of one-fifth — of the stocks in the sample.
Before passing final judgment on the rationality of the stockinvestors of 1929, we should observe that the test of stock values
applied here is somewhat conservative. The formula used for
calculating appropriate price-earnings ratios posits that a growth
stock will, at the end of its brief rapid-growth phase, abruptly shift
into low gear and grow at a modest "normal" rate. Experience
suggests that, for many industries, a gradually declining growth
rate after a period of rapid growth is probable. A formula incorporating such an assumption would yield higher estimates of
appropriate price-earnings ratios than those calculated above.
Nevertheless, even by the stiff standards of my calculations, the
price-earnings ratios in Table I hardly present a picture of a
''speculative orgy" in "a time of madness." At least half the twentynine participants appear to have been cold sober. Some showed
signs of over-indulgence. But, by the usual standards for such
things, the conclusion would have to be: not much of an orgy.




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231