A Review of The Future for Investors

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Jeremy Siegel’s The Future For Investors: Why the Tried and the True Triumph Over the Bold and the New, was a follow-up to his Stocks for the Long Run, which was originally published in 1994. Stocks for the Long Run is rightly considered the “holy bible” for buy-and-hold investors. In the book, Siegel analyzed historical stock returns for the US equity market starting from 1802. His conclusion was that stock returns will dominate those of all other asset classes over the long-run. If stocks are the asset class you should own for the long-run, then The Future for Investors helps answers one question: which stocks should you own for the long-run?

There are five parts of the book. The first part deals with the commonly held mis-perception that growth stocks will always outperform value. There is nothing wrong with growth per se, the problem occurs when investors pay-up excessively for growth. Part two deals with overvaluation in relation to IPOs and why they should be avoided. Part three discusses the importance of dividends in overall stock returns. Part four addresses the aging of the developed world and the implications for financial markets. Finally part five discusses how to implement the strategies mentioned in the book in your own portfolio.

Based on his research, Siegel concludes that the corporate equivalent of El Dorado does in fact exist. El Dorado refers to a mythical city of gold. Beginning in the 1500s European explorers searched throughout Latin and South America for this legendary city. Its mythical status grew so large that it enticed treasure seekers for over two centuries. Unlike El Dorado, individual stocks that have outperformed the market over the long-term do in fact exist. For example Siegel states:

“From the end of 1925 through the end of 2003, Philip Morris delivered a 17 percent compounded annual return, 7.3 percent greater than the market indexes. An initial $1,000 invested in this firm in 1925, with dividends reinvested, would now be worth over a quarter billion dollars!”

A certain segment of value investors make the blind assumption that buying and holding high quality companies will generate market beating returns over time. Their belief is based solely on the results of one data point, namely Warren Buffett. I found it reassuring as an investor that Siegel found numerous examples of stocks that outperformed the S&P 500 and was able to identify their common characteristics. Siegel’s research provides empirical evidence for why Buffett’s long-term investing approach works.

Siegel calculated the performance of the top 20 surviving firms from the original S&P 500 list. The S&P 500 index in its present form began on March 4, 1957. He found that total shareholder return for each company on the survivor list beat the return on the S&P 500 by at least two and three-quarters percentage points. One of the biggest takeaways from the book is that two industries dominated the survivor list: well-known consumer brand companies and large, well-known pharmaceutical companies. Siegel refers to these stocks as the tried and true, while Buffett would refer to them as having “wide moats”. It’s not a coincidence that many names on the survivor list are companies that Buffett already owns such as Coca Cola and H.J. Heinz. From my perspective these companies were able to succeed over the long term because they are essentially selling a timeless product such as candies, ketchup and chewing gum. Additionally, they developed strong brands and expanded globally, which has led to consistent earnings growth.

Siegel also confirms that total shareholder return is a function of not only the underlying earnings stream of a company but also valuation. Superior returns can only be generated when earnings grow at a higher rate than investors initially expected. Philip Morris was the best performing stock from the survivor list because its valuation has always been kept in check by the risk of continued tobacco consumption lawsuits. Siegel states in the book:

“There was no question that the earnings of these winning firms grew rapidly, far faster than the earnings of the S&P 500 Index. But the average valuation of these firms, measured by the price-to-earnings ratio, was only slightly above the average stock in the index. This indicates that investors expected these firms’ earnings to grow only slightly faster than the earnings of the average stock in the S&P 500 index. The fact that the average earnings of these firms grew almost four percentage points per year above the average firm in the S&P 500 index over nearly half a century explains their superior returns.”

If you’re a value investor and strapped for time, I would recommend reading just part one of the book. You’ll get a great overview of the characteristics that make a winning long-term stock. In addition, the empirical evidence for why Buffett’s approach to investing produces such excellent returns will also be comforting reading material.

Part two of the book deals with the issue of overvaluation. The entire section of the book can be summarized into the following rule: never buy what Wall Street is selling. The track record for IPOs is apalling. Yet investment bankers continually bring new issues to the market because there is an insatiable appetite for new listings. As a former investment banker, I can tell you from personal experience that the likelihood of retail investor making money in a “hot” IPO is close to zero. The only people making money are the venture capitalists, investment bankers and institutional investors who get in at the actual IPO price.

I have never understood why retail investors continue to fawn over IPOs. Have investors not learned anything from the dot-com bubble? The failure of the recent King Digital Entertainment IPO only confirms my belief that investors are far from the rational, emotionless automatons that economists dream about. If you’re unaware, King Digital Entertainment is the maker of candy crush saga and the annoying Facebook invitations you’re constantly receiving from your friends. As I’m writing this in December, 2014 King Digital is still trading below its March 26th, 2014 IPO price of USD 22.50 and has massively underperformed the S&P 500. The pitiful track record of IPOs in generating any meaningful returns for shareholders will always serve as an excellent symbol of investor irrationality. Additionally, I’ll leave you with some parting words from Warren Buffett:

“It’s almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less-knowledgable buyer (investors).”

Part three of the book deals with the idea of total shareholder returns and the importance of dividends. I think the most unique point that Siegel brings up is that payment of cash dividends creates trust between shareholders and management. All investors are at the mercy of corporate management when it comes to audited financial statements. Although there are red flags that highlight the potential for accounting fraud, it’s difficult to uncover. Dividends on the other hand can’t be faked. A dividend payment signifies to shareholders that the underlying corporate earnings are real. I also think dividends are a good indicator that management is shareholder focused and at least cognizant about return on capital.

Part four of the book was in my view the weakest section of the book. Although I completely agree with Siegel’s view that there will eventually be a major crisis in the US in regard to entitlement spending. I basically don’t agree with his basic premise that investors in emerging markets will bail out US investors by buying US treasury securities and US equities. Entitlement spending is growing too fast for the solution to be that simple. The endgame will be much worse than the rosy scenario Siegel predicts. I won’t go into detail more detail now, but it’s definitely worth addressing in a dedicated post.

Part five of the books was also quite useful from an investing standpoint. Siegel makes the argument as to why US investors should diversify internationally. If you’re an Indian investor the same principle applies in the sense that you shouldn’t just be holding a basket of domestic stocks. There are a number of attractive stocks and markets globally that should also be a part of a well diversified portfolio. Finally, Siegel outlines his D-I-V strategy. Essentially investors should focus on (D)ividends, (I)nternationalization and (V)aluation when constructing their stock portfolios.

If you consider yourself a value investor in the Buffett mold of buying quality businesses for the long-run, then I would recommend reading this book. It will help crystallize many of the ideas and principles you’ve internalized but haven’t explicitly thought through. If you’re strapped for time, I would recommend just reading part one. If you’re an Indian investor, the book is still a worthwhile read. Although Siegel only analyzes the US equity market, the principles covered in the book also apply to the Indian equity market. I wouldn’t let the book’s US centric focus deter you from reading it. Overall, it was a good follow-up to Stocks for the Long Run and a good supplementary text for investors who follow Buffett and read his annual reports religiously. By reading the book, you will get more insights into which stocks you should own for the long-run.

2 Comments

  • Girish Deshpande

    2015/01/12

    Sounds interesting. Would take a look at it. Recently I read a book Deep Value by Tobias E. Carlisle. In it he has analyzed Magic formula style of Greenblatt which tries to emulate such excellent companies at fair price investing model. And he claims ROIC did not add any value and in fact reduced the performance. The element that helped magic formula achieve superior returns is – EBIT/EV. Tobias has managed to convince that fair companies at excellent price may be a way to go if you desire out of chart returns…unless of course you have business analysis skills of Buffet. Would love to know your views on this if you have read this book or similar reserach by researchers.

  • Girish Deshpande

    2015/02/03

    Sounds interesting. Would take a look at it. Recently I read a book Deep Value by Tobias E. Carlisle. In it he has analyzed Magic formula style of Greenblatt which tries to emulate such excellent companies at fair price investing model. And he claims ROIC did not add any value and in fact reduced the performance. The element that helped magic formula achieve superior returns is – EBIT/EV. Tobias has managed to convince that fair companies at excellent price may be a way to go if you desire out of chart returns…unless of course you have business analysis skills of Buffet. Would love to know your views on this if you have read this book or similar reserach by researchers.