Stocks For The Long Run . . . . . . Second Edition Stocks For The Long Run The Definitive Guide to Financial Market Returns and Long-Term Investment Strategies Jeremy J. Siegel Professor of Finance— the Wharton School of the University of Pennsylvania McGraw-Hill New York San Francisco Washington, D.C. Auckland Bogotá Caracas Lisbon London Madrid Mexico City Milan Montreal New Delhi San Juan Singapore Sydney Tokyo Toronto I . . . Library of Congress Cataloging-in-Publication Data Author: Siegel, Jeremy J. Title: Stocks for the long run/Jeremy J. Siegel. Edition: 2nd ed. Published: New York: McGraw-Hill, 1998. Description: p. cm LC Call No.: HG4661 .S53 1998 ISBN: 007058043X Notes: Includes index. Subjects: Stocks. Stocks—History. Rate of return. Control No.: 98005103 Copyright © 1998, 1994 by Jeremy J. Siegel. All rights reserved. Printed in the United States of America. 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II CONTENTS Acknowledgments xi Foreword xiii Preface xvi Part 1 The Verdict of History Chapter 1 Stock and Bond Returns Since 1802 3 "Everybody Ought to be Rich" 3 Financial Market Returns from 1802 5 Historical Series on Bonds 7 The Price Level and Gold 9 Total Real Returns 10 Interpretation of Returns 12 Long Period Returns 12 Short Period Returns 13 Real Returns on Fixed-Income Assets 14 Explanations for the Fall in Fixed-Income Returns 15 Equity Premium 16 International Returns 18 Germany 19 United Kingdom 20 Japan 20 Foreign Bonds 21 Conclusion 22 Appendix 1: Stocks from 1802 to 1871 22 Appendix 2: Arithmetic and Geometric Returns 23 III Chapter 2 Risk, Return and the Coming Age Wave 25 Measuring Risk and Return 25 Risk and Holding Period 26 IV Investor Holding Periods 28 Investor Returns from Market Peaks 29 Standard Measures of Risk 31 Correlation Between Stock and Bond Returns 33 Efficient Frontiers 35 Recommended Portfolio Allocations 36 Inflation-Indexed Bonds 38 The Coming Age Wave 38 Solution to the "Age Wave Crisis" 41 Chapter 3 Perspectives on Stocks as Investments 43 Early Views of Stock Investing 45 Influence of Smith's Work 46 Common Stock Theory of Investment 48 A Radical Shift in Sentiment 49 Post-Crash View of Stock Returns 49 Investment Philosophy and the Valuation of Equity 51 Part 2 Stock Returns Chapter 4 Stocks, Stock Averages, and the Dow Strategy 55 Market Averages 55 The Dow-Jones 55 Computation of the Dow Index 57 Long-Term Trends in the Dow-Jones 58 Use of Trend Lines to Predict Trends 59 Value-Weighted Indexes 60 The Cowles Index 60 V Standard & Poor's Index 60 Indexes of Large and Small U.S. Stocks 61 Market Capitalization of Individual Stocks 62 Return Biases in Stock Indexes 63 Dow 10 Strategy 65 How to Play the Dow 10 Strategy 68 Appendix A: What Happened to the Original 12 Dow Industrials? 69 VI Chapter 5 Dividends, Earnings, and Investor Sentiment 71 An Evil Omen Returns 71 Valuation of Cash Flows from Stocks 73 Short and Long-Term Returns from Stocks 74 Sources of Shareholder Value 76 Does the Value of Stocks Depend on Dividends or Earnings? 78 Total Returns to Stocks 79 Economic Growth, Earnings Growth, and P-E Ratios 80 Historical Yardsticks for Valuing the Market 81 Price-Earnings Ratios and the Rule of 19 81 Book Value, Market Value, and "Tobin's Q" 82 Corporate Profits and Market Value to GDP 85 Valuation: Fundamentals or Sentiment? 86 Contrarian Indicators 87 Current Trends and Conclusions 89 Chapter 6 Large Stocks, Small Stocks, Value Stocks, Growth Stocks 91 Outperforming the Market 91 Risks and Returns in Small Stocks 92 Trends in Small Stock Returns 94 Value Criteria 96 Price-Earnings Ratios 96 Price-to-Book Ratios 97 Value and Growth Stocks 98 Dividend Yields 100 Distressed Firms 101 Initial Public Offerings 102 VII Are Small Stocks Growth Stocks? 103 Investment Strategy 103 Chapter 7 The Nifty Fifty Revisited 105 The Nifty Fifty 106 Returns of the Nifty Fifty 106 Evaluation of Data 108 VIII What is the Right P/E Ratio to Pay for a Growth Stock? 110 Earnings Growth and Valuation 111 Conclusion 112 Appendix: Corporate Changes in the Nifty Fifty Stock 113 Chapter 8 Taxes and Stock Returns 115 Historical Taxes on Income and Capital Gains 115 A Total After-Tax Returns Index 117 The Benefits of Deferring Capital Gains Taxes 119 Stocks or Bonds in Tax-Deferred Accounts? 121 Summary 122 Appendix: History of the Tax Code 122 Chapter 9 Global Investing 124 Foreign Stock Returns 124 Summary Data on Global Markets 126 Economic Growth and Stock Returns 129 Sources of Dollar Risk in International Stocks 131 Exchange-Rate Risk 131 Diversification to Foreign Stocks 132 Optimal Allocation for Foreign Equities 132 Cross-Country Correlations of Stock Returns 134 Hedging Foreign Exchange Risks 135 Stocks and the Breakdown of the European Exchange-Rate Mechanism 136 Summary 139 Part 3 Economic Environment of Investing Chapter 10 Money, Gold, and Central Banks 143 IX [...]... edition of Stocks for the Long Run willingly updated their data for this second edition I include Lipper Analytical Services and the Vanguard Group for their mutual funds data, Morgan Stanley for their Capital Market indexes, Smithers & Co for their market value data and Bloomberg Financial for their graphic representations On a professional level, I have benefited, as I did with the first edition,... for shares, and therefore enabled long- term investors to reap superior returns One interpretation of the current bull market indicates that investors are finally bidding equities up to the level that they should be on the basis of their historical risks and returns My contacts with shareholders reveal a remarkable acceptance of the core thesis of my book: that stocks are the best and, in the long run, ... illustrative of an important theme in the history of Wall Street But this theme is not the prevalence of foolish optimism at market peaks; rather, it is that over the last century, accumulations in stocks have always outperformed other financial assets for the patient investor Even such calamitous events as the Great 1929 Stock Crash did not negate the superiority of stocks as long- term investments Financial... to the questions that audiences have asked and contemplated the many letters and phone calls from readers The second edition of Stocks for the Long Run not only updates all the material presented in the 1994 edition, but adds a great many new topics that have resulted from my interaction with investors These include "Age Wave" investing and the fate of the baby boomers' huge accumulation of assets, the. .. the evidence to support his case for investing in stocks for the long run But this book is far more than its title suggests You will learn a lot of economic theory along the way, garnished with a fascinating history of both the capital markets and the U.S economy By using history to maximum effect, Professor Siegel gives the numbers a life and meaning they would never enjoy in a less compelling setting... book will very likely yield positive results for investors, you must remember that the odds are even higher that uncertainty will forever be your inseparable companion PETER BERNSTEIN XXII PREFACE I wrote the first edition of Stocks for the Long Run with two goals in mind: to record and evaluate the major factors influencing the risks and returns on stocks and fixed-income assets, and to offer strategies... "Nifty Fifty" growth stocks have been born, echoing the surprising results of my reevaluation of that original group that so captured Wall Street 25 years earlier The popularity and acceptance of the concepts and strategies presented in Stocks for the Long Run has far exceeded my expectations Over the past four years I have given scores of lectures on the stock market in both the U.S and abroad I have... transformed into the foremost political and economic power in the world.6 The third subperiod, from 1926 to the present, contains the 1929-32 stock collapse, the Great Depression, and postwar expansion The data from this period have been analyzed extensively by academics and professional money managers, and have served as a benchmark for historical returns.7 Figure 1-1 tells the story It depicts the. .. $11.17 at the end of 1997 That is actually less than the change in the overall price level! In the long run, gold offers investors some protection against inflation, but little else Whatever hedging property precious metals possess, these assets will exert a considerable drag on the return of a long- term investor's portfolio.11 Total Real Returns The focus of every long- term investor should be the growth... just $15 per month into good common stocks, investors could expect their wealth to grow steadily to $80,000 over the next 20 years Such a return—24 percent per year—was unprecedented, but the prospect of effortlessly amassing a great fortune seemed plausible in the atmosphere of the 1920s bull market Stocks excited investors, and millions put their savings into the market seeking quick profit On September . Stocks For The Long Run . . . . . . Second Edition Stocks For The Long Run The Definitive Guide to Financial Market Returns and Long- Term Investment Strategies Jeremy. Stocks for the Long Run willingly updated their data for this second edition. I include Lipper Analytical Services and the Vanguard Group for their mutual funds data, Morgan Stanley for their. authoritative information in regard to the subject matter covered. It is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, or other professional