This book will turn some heads. It issues a withering blow to growth and technology enthusiasts and clearly establishes what many investors have either suspected or known for a long time: Dividends are a proven vehicle for healthy long-term total returns.
And as it turns out, Siegel's extensive research into the drivers of individual stock performance backs the foundation of Morningstar's philosophy: Seek companies with economic moats and buy at attractive valuations.
Professor Siegel Rides Again
The famed Wharton professor is the godfather of the bull market. In his influential 1994 book, Stocks for the Long Run
, Siegel built a compelling case that stocks are not only the highest-returning asset class, but an asset class that becomes less risky with longer holding periods, eventually becoming less risky in real terms (that is, measured by purchasing power) than fixed-income instruments.
By redefining the notion of risk and what type of rewards to expect, Siegel did as much as anyone in academia to usher millions of new investors into the stock market.
But Stocks for the Long Run
dealt primarily with stocks as an asset class and devoted relatively little space to what specific stocks or sectors investors should own, which indirectly implied that index funds were as good as anything. The Future for Investors
picks up where Siegel's last book left off: What are the market's internal drivers, and how can we pick the best stocks?
Growth Does Not Equal Return
The centerpiece of Siegel's latest research is a bunker-busting review of S&P 500 constituents from the inception of the index in 1957 through the end of 2003. Why bunker-busting? Technology--the engine of economic growth, ostensibly the wellspring of wealth--is finally revealed with mathematical certainty as having been a raw deal for the average investor.
Let's say it's 1950. You have just two stocks to pick from: Standard Oil of New Jersey and International Business Machines
. One is a lumbering behemoth in a stagnating, cyclical, heavily regulated business. The other, much smaller, holds a near monopoly on what looks to be one of the greatest growth fields in history.
Siegel found that Standard Oil of New Jersey (which became ExxonMobil
) was the better investment by 0.6% per year--and over 53 years, that results in 32% greater compounded value. IBM's sales, earnings, and even dividends all (predictably) grew faster than ExxonMobil's. Unfortunately for IBM shareholders, IBM started out with a yield of about 2%, while ExxonMobil was paying 5%. ExxonMobil's lower valuation, higher dividends, and--this is critical--the opportunity to reinvest dividends in more low-priced, high-yielding stock more than made up for the difference in earnings growth.
There's ample evidence that seeking above-average yields (and picking up value-priced bargains in the process) leads to outsized returns; this is basically the "dogs of the Dow" strategy played out on a larger field. Siegel reports that a portfolio owning the 100 top-yielding S&P stocks beat the index by 3 percentage points annually and smacked the lowest-yielding 100 by nearly 5 points. And so much for reward being earned by taking risk: The highest-yielding quintile was slightly more volatile than the index, but the lowest-yielding stocks were the riskiest of all.
Uncovering the Trap
The economy has changed over the years, and technology and other fast-growing firms usually appear to be at the forefront of such change. Who would want to be left behind in the 1950s with a portfolio of, say, railroad stocks?
Siegel found that tech stocks were poor contributors to the S&P 500 over time, but that well established, mature, and even declining firms--including the aforementioned rails--could outperform the average. Not only are the big success stories like Microsoft
overwhelmed by the legions of losers, but even high-tech winners are added to the index at high valuations, pummeling subsequent returns. So who sees the benefits of technology? Siegel writes, "the innovators and founders, the venture capitalists…the investment bankers…and ultimately the consumer, who buys better products at lower prices." Reality thus comes into focus: You don't need to invest in technology to benefit from the industry's contribution to the economy. Better, in fact, to invest just about anywhere else.
What to Buy
Siegel suggests investors pursue what he calls "corporate El Dorados"--firms that maintain attractive growth and returns over very long periods. In Siegel's words, "persistence of good earnings growth is better than a transience of superb growth." Altria
, Tootsie Roll , Colgate-Palmolive
, and Royal Dutch Petroleum
would earn that label.
But these El Dorados are definitely high-return, in terms of return on invested capital and total return provided to investors. What these firms have in common are economic moats. After all, El Dorado refers to a mythical city of limitless wealth. If there weren't some barrier to entry in such a place, one would quickly discover limits.
Siegel also demolishes the "growth at any price" theory: "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 and the growth that investors expected."
If there is a weakness in Siegel's arguments, it's a reliance on past performance, which in turn is not always supported by solid fundamentals. For example, Siegel revisits the consistent 6.5%-7% real return provided by stocks since 1801 ("Siegel's constant," according to money manager Andrew Smithers and fellow academic Stephen Wright) only to note that the reason is not well understood. That may be so, but it's easy to frame a case that returns since World War II have been inflated by expanding valuations, which in turn suggest that 6.5%-7% real returns will be harder to achieve in the future.
I wouldn't put too much stock (so to speak) in Siegel's constant for the foreseeable future. The book's best insights aren't into the future of market returns, but into the techniques of stock selection. With Siegel's new research in hand, I'll venture that a focus on attractively valued, moat-protected dividend payers will continue providing handsome returns.
My Recommendation: Buy This Book
I've barely scratched the surface of The Future for Investors
. It stands as one of the best books on investing I've read in years. With a wealth of practical, hard-hitting guidance, it's worth the space it would occupy on any investor's bookshelf.
This article is from a recent issue of
Morningstar DividendInvestor, our monthly newsletter dedicated to helping investors find high-dividend stocks with superior long-term return potential. To review a risk-free trial issue of DividendInvestor and receive three free investing reports, click here
This article originally ran on Morningtstar.com on April 6, 2005.