Fortune Magazine's Investor Guide 2005
The December 27, 2004 "special issue" of Fortune magazine is out, and among the very interesting topics therein is a book excerpt on the new Jeremy Siegel book (beginning on page 165), "The Future For Investors."
In this book, Jeremy Siegel shows why the tried and true beats the hot and new. His research shows that not only do new firms and new industries fail to deliver good returns for investors, but their returns are often inferior to those of older companies in slow-growing or even shrinking industries.
How can this happen? There's one simple reason: In their enthusiasm to embrace the new, investors invariably pay too high a price for a piece of the action and are doomed to suffer poor returns. The concept of growth is so avidly sought after that it lures investors into overpriced stocks in fast-changing and overly competitive industries, where the few big winners cannot begin to compensate for the myriad losers. And Siegel calls this, "The Growth Trap."
Then Siegel reminds the reader that the basic principle of investor return states: The long-term return on a stock depends not on the actual growth of its earnings, but on the difference between its actual earnings growth rate and the rate that investors expected. Investors will receive a superior return only when earnings grow at a rate higher than expected, no matter whether that growth rate is high or low.
The power of the basic principle of investor return is magnified when the stock pays a dividend. Consider this. If earnings are better than expected, that means the stock is underpriced, and purchasing more shares through dividend reinvestment will enhance your returns even more.
So your ultimate goal is to find stocks whose growth will be high relative to expectations. The best way to determine those expectations is by looking at the price/earnings ratio of a stock. High P/E ratios mean that investors expect above-average earnings growth, while low P/E ratios indicate below-average growth expectations.
What are the most important lessons that can be taken from this discussion?
1. The basic principle of investor return states that stockholder returns are driven by the difference between actual and expected earnings growth, and the impact of this difference is magnified by dividends.
2. The best-performing firms for investors have been those with strong brand names in the consumer-staples and pharmaceutical industries.
3. No technology or telecommunications firm made the list of best-performing stocks. This is because investors generally expect the technology firms to have very strong earnings growth, so even when these firms do prosper, these optimistic expectations have already been built into their prices.
4. The majority of best-performing firms have had slightly higher-than-average P/E ratios and average dividend yields but much higher-than-average long-term earnings growth. None of them had an average P/E over 30.
5. Portfolios invested in the lowest-P/E stocks (those with modest expectations for growth) far outperformed those with higher valuations and expectations.
6. Be ready to pay up for good stocks, but there is no such thing as a "buy at any price." Buying stocks with proven long-term growth potential at moderate valuations is the key to a winning strategy!
Bottom Line: the lower a stock's P/E ratio, the more the stock is likely to return.
* * * * *
In this book, Jeremy Siegel shows why the tried and true beats the hot and new. His research shows that not only do new firms and new industries fail to deliver good returns for investors, but their returns are often inferior to those of older companies in slow-growing or even shrinking industries.
How can this happen? There's one simple reason: In their enthusiasm to embrace the new, investors invariably pay too high a price for a piece of the action and are doomed to suffer poor returns. The concept of growth is so avidly sought after that it lures investors into overpriced stocks in fast-changing and overly competitive industries, where the few big winners cannot begin to compensate for the myriad losers. And Siegel calls this, "The Growth Trap."
Then Siegel reminds the reader that the basic principle of investor return states: The long-term return on a stock depends not on the actual growth of its earnings, but on the difference between its actual earnings growth rate and the rate that investors expected. Investors will receive a superior return only when earnings grow at a rate higher than expected, no matter whether that growth rate is high or low.
The power of the basic principle of investor return is magnified when the stock pays a dividend. Consider this. If earnings are better than expected, that means the stock is underpriced, and purchasing more shares through dividend reinvestment will enhance your returns even more.
So your ultimate goal is to find stocks whose growth will be high relative to expectations. The best way to determine those expectations is by looking at the price/earnings ratio of a stock. High P/E ratios mean that investors expect above-average earnings growth, while low P/E ratios indicate below-average growth expectations.
What are the most important lessons that can be taken from this discussion?
1. The basic principle of investor return states that stockholder returns are driven by the difference between actual and expected earnings growth, and the impact of this difference is magnified by dividends.
2. The best-performing firms for investors have been those with strong brand names in the consumer-staples and pharmaceutical industries.
3. No technology or telecommunications firm made the list of best-performing stocks. This is because investors generally expect the technology firms to have very strong earnings growth, so even when these firms do prosper, these optimistic expectations have already been built into their prices.
4. The majority of best-performing firms have had slightly higher-than-average P/E ratios and average dividend yields but much higher-than-average long-term earnings growth. None of them had an average P/E over 30.
5. Portfolios invested in the lowest-P/E stocks (those with modest expectations for growth) far outperformed those with higher valuations and expectations.
6. Be ready to pay up for good stocks, but there is no such thing as a "buy at any price." Buying stocks with proven long-term growth potential at moderate valuations is the key to a winning strategy!
Bottom Line: the lower a stock's P/E ratio, the more the stock is likely to return.
* * * * *
posted by Bob Moser at
5:12 PM
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