Jeremy Siegel’s The Future for Investors: Why the Tried and the True Triumph Over the Bold and the New, which was originally published in 1994. Stocks for the Long Run is rightly considered the “holy bible” for buy-and-hold investors. In the book, Siegel analyzed historical stock returns for the US equity market starting from 1802. His conclusion was that stock returns will dominate those of all other asset classes over the long-run. If stocks are the asset class you should own for the long-run, then The Future for Investors helps answers one question: which stocks should you own for the long-run?
There are five parts of the book. The first part deals with the commonly held mis-perception that growth stocks will always outperform value. There is nothing wrong with growth per se, the problem occurs when investors pay-up excessively for growth. Part two deals with overvaluation in relation to IPOs and why they should be avoided. Part three discusses the importance of dividends in overall stock returns. Part four addresses the aging of the developed world and the implications for financial markets. Finally part five discusses how to implement the strategies mentioned in the book in your own portfolio.
Based on his research, Siegel concludes that the corporate equivalent of El Dorado does in fact exist. El Dorado refers to a mythical city of gold. Beginning in the 1500s European explorers searched throughout Latin and South America for this legendary city. Its mythical status grew so large that it enticed treasure seekers for over two centuries. Unlike El Dorado, individual stocks that have outperformed the market over the long-term do in fact exist. For example Siegel states:
“From the end of 1925 through the end of 2003, Philip Morris delivered a 17 percent compounded annual return, 7.3 percent greater than the market indexes. An initial $1,000 invested in this firm in 1925, with dividends reinvested, would now be worth over a quarter billion dollars!”
A certain segment of value investors make the blind assumption that buying and holding high quality companies will generate market beating returns over time. Their belief is based solely on the results of one data point, namely Warren Buffett. I found it reassuring as an investor that Siegel found numerous examples of stocks that outperformed the S&P 500 and was able to identify their common characteristics. Siegel’s research provides empirical evidence for why Buffett’s long-term investing approach works.
Siegel calculated the performance of the top 20 surviving firms from the original S&P 500 list. The S&P 500 index in its present form began on March 4, 1957. He found that total shareholder return for each company on the survivor list beat the return on the S&P 500 by at least two and three-quarters percentage points. One of the biggest takeaways from the book is that two industries dominated the survivor list: well-known consumer brand companies and large, well-known pharmaceutical companies. Siegel refers to these stocks as the tried and true, while Buffett would refer to them as having “wide moats”. It’s not a coincidence that many names on the survivor list are companies that Buffett already owns such as Coca Cola and H.J. Heinz. From my perspective these companies were able to succeed over the long term because they are essentially selling a timeless product such as candies, ketchup and chewing gum. Additionally, they developed strong brands and expanded globally, which has led to consistent earnings growth.
Siegel also confirms that total shareholder return is a function of not only the underlying earnings stream of a company but also valuation. Superior returns can only be generated when earnings grow at a higher rate than investors initially expected. Philip Morris was the best performing stock from the survivor list because its valuation has always been kept in check by the risk of continued tobacco consumption lawsuits. Siegel states in the book:
“There was no question that the earnings of these winning firms grew rapidly, far faster than the earnings of the S&P 500 Index. But the average valuation of these firms, measured by the price-to-earnings ratio, was only slightly above the average stock in the index. This indicates that investors expected these firms’ earnings to grow only slightly faster than the earnings of the average stock in the S&P 500 index. The fact that the average earnings of these firms grew almost four percentage points per year above the average firm in the S&P 500 index over nearly half a century explains their superior returns.”
If you’re a value investor and strapped for time, I would recommend reading just part one of the book. You’ll get a great overview of the characteristics that make a winning long-term stock. In addition, the empirical evidence for why Buffett’s approach to investing produces such excellent returns will also be comforting reading material.
Part two of the book deals with the issue of overvaluation. The entire section of the book can be summarized into the following rule: never buy what Wall Street is selling. The track record for IPOs is apalling. Yet investment bankers continually bring new issues to the market because there is an insatiable appetite for new listings. As a former investment banker, I can tell you from personal experience that the likelihood of retail investor making money in a “hot” IPO is close to zero. The only people making money are the venture capitalists, investment bankers and institutional investors who get in at the actual IPO price.
I have never understood why retail investors continue to fawn over IPOs. Have investors not learned anything from the dot-com bubble? The failure of the recent King Digital Entertainment IPO only confirms my belief that investors are far from the rational, emotionless automatons that economists dream about. If you’re unaware, King Digital Entertainment is the maker of candy crush saga and the annoying Facebook invitations you’re constantly receiving from your friends. As I’m writing this in December, 2014 King Digital is still trading below its March 26th, 2014 IPO price of USD 22.50 and has massively underperformed the S&P 500. The pitiful track record of IPOs in generating any meaningful returns for shareholders will always serve as an excellent symbol of investor irrationality. Additionally, I’ll leave you with some parting words from Warren Buffett:
“It’s almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less-knowledgable buyer (investors).”
Part three of the book deals with the idea of total shareholder returns and the importance of dividends. I think the most unique point that Siegel brings up is that payment of cash dividends creates trust between shareholders and management. All investors are at the mercy of corporate management when it comes to audited financial statements. Although there are red flags that highlight the potential for accounting fraud, it’s difficult to uncover. Dividends on the other hand can’t be faked. A dividend payment signifies to shareholders that the underlying corporate earnings are real. I