“The Future for
Investors”
by Jeremy Siegel
Kevin Kranzler
Lisa Lajeunesse
Ray Ng
John Schmidt
Agenda
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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%
Total Return
13.83%
14.42%
Standard Oil
of NJ
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
Highest Priced Stocks
S&P 500 Benchmark
Lowest Priced Stocks
1957 Initial
Investment
$1,000
$1,000
$1,000
2003 Investment Annual Rate
Value
of Return
$56,661
9.17%
$130,768
11.18%
$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
of $1000
1
Phillip Morris
$4,626,402
2
Abbott Labs
$1,281,335
3
Bristol-Myers Squibb
$1,209,445
4
Tootsie Roll Industries
$1,090,955
5
Pfizer
$1,054,823
6
Coca-Cola
$1,051,646
7
Merck
$1,003,410
8
PepsiCo
$866,068
S&P 500
$124,486
Annual
Return
19.75%
16.51%
16.36%
16.11%
16.03%
16.02%
15.90%
15.54%
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 you’re
happy. You cost me $14,000.00 for no
reason! What do you have against this
mammoth company? Are you jealous
because you didn’t get in on the run-up? Did
you want to buy in cheaper? You have no
business making decisions like this. After all,
you’re still a child when it comes to Internet
knowledge.
Response to Wall Street Journal
Article
“You’re a preschooler in diapers when it comes
to recognizing opportunities. By the way,
when was the last time you got laid? You’re
a party pooper. Thanks a lot, jerk. I suggest
you go to the streetadvisor.com to read
about why you’re 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 IPO’s 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-Mart’s 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 company’s competitive advantage
Summary
 Never forget the fundamentals of
investing
 Watch out for bubbles
 IPO’s 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 world’s
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
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Dividends
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International
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Buy stocks that have sustainable cash flows
and return dividends
Recognize shift of economic power
Valuation
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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 today’s
market
 This book emphasizes everything you
learn in University when it comes to
investing
 Allocation portfolio a useful strategy
given a long time horizon