You have never lost money in stocks over any 20-year period, but you have wiped out half your portfolio in bonds, after
inflation. So which is the riskier asset?
This thought provoking statement is the premise of Jeremy Siegel’s groundbreaking book Stocks for the Long Run. The book,
now in its fifth edition, makes a compelling argument that stocks are less risky than bonds over time. The assertion is
that in any given year, stocks could show tremendous volatility. But over long periods, they trounce cash and high quality
bonds in terms of returns.
Professor Siegel has taught at the University of Pennsylvania’s Wharton School for over four decades. Barton Biggs refers
to him as a wise man and an astute observer of the ever changing investment universe.
Here are some insights gleaned from his book.
•It’s not just investing, but re-investing that leads to wealth accumulation.
Bear markets, which so frighten investors, pale in the context of the upward thrust of total stock returns. One dollar
invested and reinvested in stocks since 1802 would have accumulated to nearly $7,500,000 by the end of 1997.
Hypothetically, this means that $1 million, invested and reinvested during these 195 years, would have grown to the
incredible sum of nearly $7.5 trillion in 1997.
But total wealth in the stock market, or in the economy for that matter, does not accumulate as fast as the total return
index. This is because investors consume most of their dividends and capital gains, enjoying the fruits of their past
saving. It is rare for anyone to accumulate wealth for long periods of time without consuming part of his or her return.
The longest period of time investors typically plan to hold assets without touching principal and income is when they are
accumulating wealth in pension plans for their retirement or in insurance policies that are passed on to their heirs.
The stock market has the power to turn a single dollar into millions by the forbearance of generations—but few will have
the patience or desire to let this happen.
This article was also published in Morningstar on 21 June,2016
•Short-term fluctuations in the market, which loom so large to investors, have little to do with the long-term accumulation of wealth.
The reasons for the persistence and long-term stability of stock returns are not well understood.
Certainly the returns on stocks are dependent on economic growth, productivity, and the return to risk taking. But the
ability to create value also springs from skillful management, a stable political system that respects property rights,
and the need to provide value to consumers in a competitive environment.
Political or economic crises can throw stocks off their long-term path, but the resilience of the market system enables them to regain their long-term trend. Perhaps that is why stock returns transcend the radical political, economic, and social changes that have impacted the world over the past two centuries.
•Long horizons – 10 or 20 years – are far more relevant than most investors recognize. The trick is to stay through market cycles and not time them.
One of the greatest mistakes that investors make is to underestimate their holding period. This is because many investors
think about the holding periods of particular stocks or bonds. But the holding period that is relevant for portfolio
allocation is the length of time the investors hold any stocks or bonds, no matter how many changes are made among the
individual issues in their portfolio.
The upward movement of stock values over time overwhelms the short-term fluctuations in the market. There is no compelling
reason for long-term investors to significantly reduce their stockholdings, no matter how high the market seems. Of
course, if investors can identify peaks and troughs in the market, they can outperform the ''buy-and-hold" investor. But,
needless to say, few investors can do this. And even if an investor sells stocks at the peak, this does not guarantee
superior returns. As difficult as it is to sell when stock prices are high and everyone is optimistic, it is more
difficult to buy at market bottoms, when pessimism is widespread and few have the confidence to venture back into stocks.
A number of "market timers" boasted how they yanked all their money out of stocks before the 1987 stock crash. But many
did not get back into the market until it had already passed its previous highs. Despite the satisfaction of having sold
before the crash, many of these "market seers" realized returns inferior to those investors who never tried to time the
•Lessons from the Nifty-Fifty.
The Nifty-Fifty were a group of premier growth stocks, such as Xerox, IBM, Polaroid and Coca-Cola, that soared in the
early 1970s. All had proven growth records, continual increases in dividends and high market capitalization. The Nifty
Fifty were often called one-decision stocks: buy and never sell. Because their prospects were so bright, many analysts
claimed that the only direction they could go was up.
The average PE ratio of these stocks was 41.9 in 1972, more than double that of the S&P 500’s 18.9, while their 1.1%
dividend yield was less than half that of other large stocks. Over one-fifth of these firms sported PE ratios in excess of
50, and Polaroid was selling at over 90 times earnings.
After the vicious 1973–74 bear market, which slashed the value of most of the “Nifty Fifty,” many investors vowed never
again to pay over 30 times earnings for a stock. But is the conventional wisdom justified that the bull market of the
early 1970s markedly overvalued these stocks? Or is it possible that investors were right to predict that the growth of
these firms would eventually justify their lofty prices? To put it in more general terms: What premium should an investor
pay for large, well-established growth stocks?
On a detailed analysis of the data over 25 years, Siegel found that many of these stocks were worth far more than even the
lofty heights that investors bid them. For instance, Coca-Cola Corporation carried a very pricey 46.4 multiple in 1972,
which many analysts claimed was far too high. But on the basis of its future returns, Coke was worth over 90x earnings.
In contrast to brand-name consumer stocks, the technology stocks such as IBM, Polaroid and Xerox failed. His study
revealed that an equally weighted portfolio of Nifty Fifty stocks (mix of winners and losers) was worth 40.5x its 1972
earnings, marginally less than the 41.9 ratio that investors paid for them.
In Revisiting the Nifty-Fifty, he says investors can learn three lessons:
1) You must pay for growth.
Growth stocks often sport very high price-earnings multiples, but stocks that are able to consistently maintain earnings
growth year-after-year are often worth far more than the multiple that Wall Street considers “reasonable.” According to
his study, stocks with steady growth records are worth 30, 40, and sometimes more times earnings. Good growth stocks, like
good wines, are often worth the price you have to pay.
2) Don’t “pay any price”.
Among these good growth stocks, those with the lower price-earnings ratios tended to outperform those with higher price-earnings ratios. When examining growth stocks, don’t be scared off by high absolute price earnings ratios, but try to cull out those growth stocks with lower price-earnings ratios.
3) Be diversified among various growth stocks and groups.
Despite their dazzling performance, buying just a few of these growth stocks was quite dangerous. Among the many gems were
bad apples. Even whole industries, like technology, that had enriched so many investors in the 1960s, vastly
underperformed the market in the next 26 years. Diversification is a key to cutting risks and maintaining returns. No one
stock or single industry is guaranteed to succeed.
•Indexing with a twist.
Though not in the book, but worth a mention, is when asked about the best investment advice he ever received, he cites
Paul Samuelson’s mention about low-cost indexed investments. In fact, Siegel was one of the very first investors in the
Vanguard S&P 500 Index Fund. In the first edition of his book, he strongly advocated indexed investments.
Along came the tech bubble at the turn of the century. Even though tech stocks shot up phenomenally, way above fundamental
values, the indexed investor had to hold on to them in proportion to their market value, which was very substantial. That
is when he began to look at fundamental indexing.
Rather than assembling an index by its market capitalization, fundamental indexing uses other metrics such as earnings,
dividend yield or book value. The result is a passively managed fund that avoids getting overweighted in specific stocks
and industries. Siegel has two principle strategies: High-dividend stocks and low P/E stocks.
In fact, he told a reporter that the bulk of his equity holdings are in funds that are fundamentally indexed, covering
different regions of the world. He certainly puts his money where his mouth is.
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