Jeff Brown PERSONAL FINANCE
Good news: If you want to invest in the most promising stocks for the next 50 years, you don't need to read up on nanotechnology, fuel cells or genetic engineering.
Chances are you'll do better with companies that produce humdrum products you'll find around the home: soda pop, food and household supplies, gasoline and medicine.
So concludes Wharton finance Professor Jeremy Siegel in his new book, released last week, "The Future for Investors: Why the Tried and True Triumphs Over the Bold and New."
Siegel is best known for his 1994 bestseller "Stocks for the Long Run," which showed how stocks had dramatically beaten bonds and cash for the past two centuries. The new work looks at which stocks do best, then examines stocks' prospects in the coming decades of globalization.
"The future is bright," Siegel announces in his first chapter. "Our world today stands at the brink of the greatest burst of invention, discovery and economic growth ever known. The pessimists, who proclaim that the retiring baby boomers will bankrupt Social Security, upend our private pension systems and crash the financial markets, are wrong."
Siegel found that the top performers from among big stocks around since 1950 were not the cutting-edge tech firms such as IBM but the ordinary companies: National Dairy Products (now Kraft), R.J. Reynolds Tobacco, Standard Oil of New Jersey (now ExxonMobil), and Coca-Cola.
With dividends reinvested, $4,000 put into these four would now be worth $6.29 million, vs. $1.11 million for the average stock.
IBM trailed all those stocks. It returned 13.83 percent a year, while Standard Oil, for example, returned 14.42 percent. That small-looking difference would have caused the Standard Oil investment to grow 25 percent larger over 53 years.
Siegel also examines stocks that, at one time or another, have been on the Standard & Poor's 500 index, created in 1957 with the 500 largest stocks. Since then, more than 900 additional companies have spent time in the index as original members were removed. But as a group, the 900 newer stocks did worse than the original 500 - the older companies with less sexy products.
Because investors eager to own stocks in firms with hot new products consistently paid too much for the shares. Remember the tech-stock bubble that burst five years ago?
From 1950 through 2003, IBM shares traded at prices averaging nearly 27 times the company's annual earnings. Standard Oil was a bargain next to that, with an average price-to-earnings ratio of about 13.
Because of its high share price, IBM's dividend yield (annual dividend divided by price) was a mere 2.18 percent, compared to 5.19 percent for Standard Oil. The oil company's shareholders, thus, accumulated many more shares from reinvested dividends, causing their holdings to snowball.
Investors can be excused for getting excited by IBM, since it beat Standard Oil in per-share growth of revenue, dividends and earnings.
But this led them into what Siegel calls "the growth trap." They paid too much for the shares because they expected more growth than the company would deliver.
The key to a stock's success is not how fast earnings grow but whether they grow faster than investors expected, Siegel found. This holds true for entire sectors as well. Railroads, a shrinking sector, have beaten the S&P 500 over the past half-century because their earnings did better than expected.
Siegel's conclusion: Invest in stocks with high dividend yields and low price to earnings ratios, which reflect investors' low expectations. Spurn anything "hot," like a stock in its initial public offering.
He has much more to say, so on in a later column I'll look at why he urges investors to put 40 percent of their stock holdings into foreign issues, and why he thinks investors in China, India and other developing nations will finance American baby boomers' retirements.
Jeff Brown is a business columnist for The Philadelphia Inquirer. E-mail him at firstname.lastname@example.org.