Tuesday, July 04, 2006

Siegel on The Future for Investors

I recently finished reading The Future for Investors (2005) by Dr. Jeremy Siegel, the well-known Wharton professor who authored the widely cited Stocks for the Long Run (1994). In his latest book, he outlines his methods for selecting winning stocks for the long-term in the context of current and future trends.

The major points of the book, as I saw it:

  • Beware the "growth trap"

    In a nutshell, this means avoiding overpriced companies and industries.

    According to Siegel, fixating on high-growth companies or pursuing technological innovation is a mistake. (The subtitle of the book, in fact, is "Why the Tried and the True Triumph over the Bold and the New.") Such stocks often have high price valuations that indicate substantial built-in investor expectations. Thus the difference between expected and actual earnings is less, producing lower returns.

    The same factor can apply to industries, where he says fast growth causes increased competition amongst companies and too-high investor expectations, both of which negatively impact returns. "The financial and technology sectors expanded greatly over the past years [since 1957]," he says, "yet gave mediocre to poor returns." The three best performing sectors, Siegel says, have been health care, consumer staples, and energy--the latter of which has experienced a "significant contraction in market share."

    Siegel extends the "growth trap" lesson even to the issue of emerging markets. He uses the example of comparing Brazil and China. From 1992-2003, Brazil's economy grew at only 1.8% a year, less than one-fifth of China's. China, Siegel points out, also had a stable currency, no inflation problems, and political stability; Brazil was the opposite. Yet investment returns in Brazil averaged 15% a year while in China returns average -10% a year. The reason: "low prices and high dividend yield."

  • Seek high dividend-yield stocks

    "From 1871 to 2003," Siegel writes, "97 percent of the total after-inflation accumulation from stocks comes from reinvesting dividends. Only 3 percent comes from capital gains." Dividends are the Holy Grail of Siegel's investing strategy. Companies that pay dividends regularly, he says, inspire shareholders' trust in management. More importantly, high dividend yields lead to higher returns, where re-invested dividends act as a cushion from a decline in price They also, due to the increased number of shares now owned by the investor, accelerate returns once a stock's price turns up.

    Siegel refers constantly to a list of the 20 top-performing survivor stocks of the original S&P 500. These companies, which beat the index over the past 47 years by between 2.8-8.9% a year, all paid dividends.

    One important point to consider here is the role of taxes, which Siegel glosses over. Of course, if you are investing in an IRA or other tax-sheltered account, this isn't a problem.

  • Foreign markets will play a vital role in the global economy

    The impending demographic crisis in the developed world, Siegel warns, will have consequences. With an aging population leading to more retirees (who are also living longer) supported by fewer workers, the assets of older people will decrease in value and force the retirement age upward.

    However, Siegel thinks the answer lies in what he calls the Global Solution--"aging populations in the richer countries...supported by the young workers in the developing world." He posits that the growth of emerging economies like China and India will allow young people in those countries to purchase the assets of older people in developed countries, allowing the latter to enjoy "an ever-lengthening retirement without any reduction in the standard of living."

    The emergence of China and India, along with other promising countries like Russia and Brazil, is not without precedent. Siegel points out that in terms of U.S. per capita income, Japan has gone from 20% to 96% in the past 40 years; Singapore from 14% to 58% in the same time. In the last 25 years, South Korea has gone from 17% to 50%. I found it interesting that he says China could achieve the same goal with a productivity growth rate half of what it has averaged over the last 25 years, meaning it's more than likely to happen.

Those were the topics in the book I found most interesting. Siegel also covers other investment strategies, which I am not advocating here, in less detail. The strength of his book, however, lies in its discussion of the aforementioned themes. If you already have some experience with the stock market, and are interested in a look at what lies ahead, I think you'll find it worth a read.


Jack Nargundkar said...

Well one can avoid the "growth trap", "seek high dividend-yield stocks", and even invest in "foreign markets" - but efficient market theory postulates that it is very hard to predict whether a certain stock will out-perform the market. So I'd suggest you can't go too wrong with index or exchange-traded funds (ETFs)?

Jay said...

Your comment reminds me to point out that Siegel is talking about long-term investing--holding stocks for 20, 30 years or more. Obviously then, he is not recommending this strategy for a holding of just a few stocks, because the risk there is tremendous.

In his Stocks for the Long Run, Siegel advocated investing in broad index funds, e.g. tied to the S&P 500. In his new book, he says that performance can be beat by investing in ETFs and more focused index funds that follow the criteria I mentioned in my post. He also suggests REITs and investment strategies like the popular "Dogs of the Dow".

Common to all of those, however, is an exposure to many stocks, where your winners pay off more than enough to cover any losers.