The Future for

Investors
by Jeremy Siegel

Kevin Kranzler
Lisa Lajeunesse
Ray Ng
John Schmidt
 Agenda

Who is Jeremy Siegel?

Part 1: The Growth Trap
Part 2: Overvaluing the Very New
Part 3: Sources of Shareholder Value
Part 4: The Age Wave
Part 5: Portfolio Strategies
Overall Book Review
 Jeremy Seigel, Ph.D.

Professor of Finance at the Wharton

School of the University of Pennsylvania
Received many awards over his career
The Senior Investment Strategy Advisor
of Wisdom Tree Investments Inc.
 Part 1
The Growth Trap
 The Growth Trap

Everyone wants to beat the market &

invest in the next big thing.

However, as Siegel points out, pursuing

returns through growth continually
disappoints investors.
 Example

Table 1.1: Annual Growth Rates, 1950-2003

Growth Measures IBM Standard Oil of NJ Advantage
Revenue Per Share 12.19% 8.04% IBM
Dividends Per Share 9.19% 7.11% IBM
Earnings Per Share 10.94% 7.47% IBM
Sector Growth 14.65% -14.22% IBM
 What actually happened?

IBM: $1000 initial investment became

$961,000.

Standard Oil of NJ: $1000 initial

investment became $1,260,000.
 How is this possible?

Table 1.3: Source of Returns of IBM and Standard Oil of NJ

Standard Oil of NJ, 1950-2003
Return Measures IBM Standard Oil Advantage
of NJ
Price Appreciation 11.41% 8.77% IBM

Dividend Return 2.18% 5.19% Standard Oil

of NJ
Total Return 13.83% 14.42% Standard Oil
of NJ
 What matters!

Long-term returns on stock depends not

on the actual growth of its earnings but
on how those earnings compare to
what investors expected!
Looking for the Corporate El
Dorado

The Golden company that continually

performs better than the markets
Siegel computed the P/E ratio for all
500 firms on the S&P and computed
their prices
 What Siegel Found

High P/E stocks earn lower returns and low

P/E stocks earn high returns, on average

1957 Initial 2003 Investment Annual Rate

Investment Value of Return
Highest Priced Stocks $1,000 $56,661 9.17%
S&P 500 Benchmark $1,000 $130,768 11.18%
Lowest Priced Stocks $1,000 $426,468 14.07%
 Characteristics of Corp El
Dorado's
Earnings expectations are only slightly above
average, but actual earnings growth was
considerably large
No P/E ratio was above 27
All paid constant and rising dividends
Most have high quality brand name
recognized products that are marketed
worldwide
Consumer have trust in their product quality
 Top Eight Performing Survivors, 1957-2003
Rank 2003 Name Accumulation Annual
of $1000 Return
1 Phillip Morris $4,626,402 19.75%
2 Abbott Labs $1,281,335 16.51%
3 Bristol-Myers Squibb $1,209,445 16.36%
4 Tootsie Roll Industries $1,090,955 16.11%
5 Pfizer $1,054,823 16.03%
6 Coca-Cola $1,051,646 16.02%
7 Merck $1,003,410 15.90%
8 PepsiCo $866,068 15.54%
S&P 500 $124,486 10.85%
 Sector Growth

Investment strategies based on

industry/sector are growing in
popularity

Morgan Stanley & Goldman Sachs

 Summary

Do not be seduced by that hot new

company or investors
Overwhelming demand for stocks
overvalues those stocks which lowers
the return for investors
 Part 2:
Overvaluing the Very
Few
How To Spot a Bubble

1.) Valuations are critical

2.) Never Fall in Love with your Stock
3.) Beware of Large, Little Known
Companies
4.) Avoid Triple Digit P/E Ratios
5.) Never Sell Short in a Bubble
 Response to Wall Street Journal
Article
Good morning, Mr. Siegel. I hope youre
happy. You cost me $14,000.00 for no
reason! What do you have against this
mammoth company? Are you jealous
because you didnt get in on the run-up? Did
you want to buy in cheaper? You have no
business making decisions like this. After all,
youre still a child when it comes to Internet
knowledge.
Response to Wall Street Journal
Article
Youre a preschooler in diapers when it comes
to recognizing opportunities. By the way,
when was the last time you got laid? Youre
a party pooper. Thanks a lot, jerk. I suggest
you go to the streetadvisor.com to read
about why youre so wrong idiot. Do you
even know how to get a Web site, you
child?
Investing in the Newest of the New
 IPO Relative Returns
Figure 6.2 Annualized Returns on Yearly IPO Portfolios Minus Returns on Sm
Stock Index, Returns Measured Through December 31, 2003
 Creative Destruction

Innovative entry by entrepreneurs is the force

that sustains economic growth
- wikipedia.com
Investors in IPOs are actually not making money
(the ground floor)
If the new are not making money for investors
then who is attaining profits?
Venture Capitalists
Investment Banks
 Capital Pigs

Technology is a productivity creator, and

a value destroyer
Profits reinvested into the company is
money that is not paid out in dividends,
destroying investor return
Fallacy of Composition
Capex Ratio
Success Amongst Failure

Wal-Marts Strategy for Success

Southwest Airlines low cost structure
Nucor Steel use of new technology
 Winning Management

consistency of the company, and our ability

to project its philosophies throughout the
whole organization, enabled by our lack of
layers and bureaucracy
The business structure should look to always
minimize costs
Define the largest controllable cost and minimize
it, this is a companys competitive advantage
 Summary

Never forget the fundamentals of

investing
Watch out for bubbles
IPOs are a bad investment for investors,
Individual company analysis is important;
look for
Lower Capex Ratios
Low P/E ratios
Winning management
 Part 3:
Sources of Shareholder
value
Correlation between Dividends and
Returns

Higher dividend paying companies

provide greater returns
Lower dividend paying companies
provide less returns
Not just due to extra cash flow
Dividends to Capital Gains
 Purpose of Dividends

Provides credibility
Indicates real earnings
Shows strength in time of
economic downturn
Price drops and dividend
yield goes up
Importance of Bear markets

One reason for the correlation

(dividends/returns)
Reinvest (increased) dividends at lower
price
Cushions portfolio in decline
Accelerates returns when price goes up
 Phillip Morris Example

Cigarette company facing lawsuits and

fierce competition
Share price fell but dividends rose
Reinvested dividends (92-03) increased
shares by 100%
7.15% annually trailed market
Prices recovered and returns magnified
Measuring Earnings to Value a
Company

Net Income sanctioned by FASB/GAAP

Operating Income reconciles one-time
cost/revenues
More accurate - restructuring costs
Manager indiscretion - amortization
Red flags to watch out for

Option expenses
Do not legally have to be recorded as expenses
Not accurate portrayal in Income statement
Pension Plan Structure
Serious claim on future earning
High Accruals
Indicate low quality earnings
 Summary

There is a positive correlation between

dividends and returns
There are numerous ways to value a
company
 Part 4:
The Age Wave
Baby Boomers Baby Bust
 Problems

Lower productivity from decreased workforce

Increased demand from more retirees
Retirees sell their assets during retirement
Flood of financial assets on market
Drive prices of equities and bonds down
Securities value is determined by price buyer is
willing to pay
 More Problems

Retirement age is decreasing

People are living longer
Results in longer non-working time
Greater pension/planning needs
Fastest age bracket growth is age 100+
 Possible Solutions

Reduce benefits of pension plans

Decrease the standard of living
Creates generational conflict
Increase Productivity
Offsets the population imbalance
Difficult to create/predict/depend on
 Possible Solutions

Increase Immigration
Increase productivity
400 million people will be required to offset
the population wave
 The Global Solution

Developing countries have opposite

population wave than the Developed
countries
India and China can support the
western countries with goods and
services/buy assets
Maintain the standard of living in
developing countries
The Global Solution [2]
 The Global Solution [3]

Enable aging nations to enjoy longer

retirement
Communications revolution will aid in
economic growth free flow of information
Free trade will become increasingly important
Advance the globalization of the worlds
economic system
 Summary

Baby boomers retirement poise a

difficult transition period for investors
Investors must seek a global solution
 Part 5:
Portfolio
Strategies
 Global Market Trends

Growth Prospects in China & India

Growth Trap
Example: Brazil vs. China
Emerging Chinese Economy
Home Equity Bias
Correlation of US & World markets
 World Portfolio

Recommended Allocation
60% American-based equity
40% foreign-based equity
How to Invest Abroad
Global Index Funds
Low cost and excellent returns
Morgan Stanley Capital International Index
Most inclusive non-U.S Indexed Fund
Global Investment Tools

MSCI EAFE Index

Dow Jones Wilshire Total Stock Index
Vipers
Spiders
Cubes
Diamonds
MSCI EAFE Index
 Future Strategies

Future is bright for investors

Growth in emerging markets
Future stock performance
Stocks to purchase
Initially broadest index possible
D-I-V Directives
 D-I-V Directives

Dividends
Buy stocks that have sustainable cash flows
and return dividends
International
Recognize shift of economic power
Valuation
Accumulate shares with reasonable valuations
relative to expected growth
Avoid IPO's, hot stocks, must-have
investments
Table 17.4 Valuation Strategies,
1957-2003
 Summary
Summary
 Overall Book Review

Overall the book provided many facts

Has practical lessons to utilize in todays
market
This book emphasizes everything you
learn in University when it comes to
investing
Allocation portfolio a useful strategy
given a long time horizon