Saturday, May 07, 2005

Siegel's constant

I was reading Arnold Kling on his Econ Log. He is one of the economists whose ideas I like. He blogs about Jeremy Siegel who is a Professor at the Wharton Business School.

Prof. Siegel talks about the Stock market and the globalizing world ecpnomy, Some excerpts.

About Siegel :

Wharton Business School Professor Jeremy Siegel is one of the world's most important scholars on stock ownership and investing. His 1994 book "Stocks for the Long Run" became an instant classic. His extensive original research found that over periods of 20 or more years, stocks are not only the best investment for your money, but the safest as well, returning 6.5 -7% after inflation (now popularly called "Siegel's constant") while bonds and other investment vehicles fared considerably less well.

The Interview :

The growth trap is falling into a pattern of just buying companies with what you think are the fastest growing earnings, and ignoring the price. It is so important to realize that when you're paying a higher than usual price, you're already putting up for those higher earnings. In fact, I find that the faster growing companies often give poorer returns for investors; those investors that chase after those fast growing companies actually suffer worse returns than those that buy slower growing companies at reasonable prices.

This surprised me. Even though IBM won, hands-down, on all the growth parameters that Wall Street looks at -- earnings per share growth, market value growth, sales -- it fell behind Standard Oil of New Jersey in terms of return for investor. And the two reasons for that: IBM sold at more than twice the price-earnings ratio of Standard Oil and had less the half the dividend rate. So when you put those two together, over the next 53 years, Standard Oil of New Jersey -- and this is even before the very latest run-up in oil prices, because I ended my first data set in 2003 -- out-performed IBM even though IBM was one of the fastest growing companies in the world.

[If you have been following Warren Buffet or reading his letters to Investors then this would be old news to you]

Absolutely. It surprised me. From 1957, when the S & P was founded, to the present, the best performing company is Philip Morris, which is now the Altria Group. It won hands-down against all the others. The returns were three percent per year more than the next best-performing stock and almost doubled the S & P over the last half century, which is really remarkable when you consider the record.

And a major reason for that performance is that no one wanted to buy it. The price stayed low. First off, there are those who object morally to cigarettes so they don't buy it. And, more importantly, those that said, oh, the government's going to put them out of business; these liability payments -- Philip Morris has already paid over $150 billion! And, as a result, the price fell so low. They were still pumping out cash and the dividend yield got to be extremely high. And, once you had reinvested dividends, the returns on that company just soared above everything else.

[In fact Phillip Morris is one company which also featured in the "Built to Last" list of Jim Collins. It is amazing that this company is in many ways one of the best managed in the US. In fact, ITC Limited in India, a tobacco company, is a similar example. I guess there is something with these cigaratte's?]

The best solution of the aging problem is what I call the 'global solution.' I think that we have to think of ourselves very much like Florida, which is an aging state. In a younger country, we don't talk about an aging crisis in the state of Florida. Their retirees sell their assets in the US to the rest of the US market that absorbs them. They import goods. They're enjoying a good retirement.

In 50 years the United States will be more aged than all of Florida is today, but we will be, existing in a younger world. So, what I see is exactly the same pattern. We will be selling assets into the world market. They will be buying, they will be absorbing, they will be saving, and they will be producing the goods that we will be importing to satisfy our retirement needs. And, I think that is the only way that we could have an ever-increasing retirement period with the shrinkage of workers and the extension of life expectancy.

Certainly India is very young country. The rest of Asia is a very young. Indonesia is very young. And even China -- I know that because of its one-child policy it is aging, but they have a huge supply of surplus labor with state-owned enterprises that they can absorb into the private sector. I expect, and I hope, that this development not only sweeps through Asia, which looks extremely promising, but also Latin America, the Middle East, and even Africa, which has been the so-called basket case. But there are a billion people in Africa -- very young ages -- and they have not yet started their growth.

India and China, by the middle of the century, will together be, in my opinion, more than four times the size of the United States.

[Since I come from India, I see that the energy levels and the sense of optimism of the future and what needs to be done is so high compared to say Australia...atleast that's the experience till now]

Technology is critical for progress. For increases in standard of living, what we call growth, it is so very important; but that doesn't mean that technology stocks are the best stocks to buy. Just like not always the best horse on paper is what you should bet on at the race track. The horse could be over-bet and as a result the odds are way too low. You've got to look at the price, as well. Too many people just look at one, without looking at the other. Technology is an unbelievable force -- the communications and Internet revolution is one of the most exciting things to ever happen. Do I want to go into those stocks? Maybe, maybe not. I want to see what people are paying for them. If everyone else is excited about something, I tend not to want it.

[Very important to understand. Systems Thinking would help in looking at the whole rather than the parts. And of course Buffet has been talking about this for some 30 years now.]

Do check this business school reading list.


Blogger DREAM said...


23 May, 2005 00:16  
Anonymous Anonymous said...

Doc said: Insightful

06 August, 2005 02:11  

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