Book of the Week: The Future For Investors
29 Aug 2015
In Siegel’s previous book, Stocks for the Long Run, he laid out that nothing beats stocks in terms of long term returns. My problem with this is that past performance is not a guaranteed of future gains. There was a 30 year period where stocks did not have any real gains when adjusted for inflation. This book, The Future for Investors, is about which stocks you should buy. Indexes are okay, but Siegel’s analysis shows that you can do better. Growth ≠ Returns
Although copying the actions of others affords some psychological comfort, it pays to stand apart from the crowd. Conventional wisdom in the financial markets is generally wrong.
The people who benefit off growth are founders, venture capital, investment banker and consumers. Investors do not profit from growth, because they are paying a premium for it. Market value and investor returns are different. When the market cap of a company goes up, either the price of the shares go up or there are more shares. Investors return is related to the change of the price per share and the dividend. If the price of a share does not change, you still get investor returns from the dividend. Basic Principle of Investor Returns
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.
In an efficient market, all the future cash flows, should be included into the price of a stock. It should not matter which one you buy since everything is priced in. You get better returns if the actual growth is better than expected growth. If you buy a high P/E stock which does not meet projected growth, you paid a premium and will not realize those returns. If you guy a low P/E stock which has dismal projected growth, but actually grows a little bit, then you will get better returns, because you bought the stock as a discount. People have a cognitive bias that swings both ways. Overly optimistic and overly pessimistic. People overvalue the new. Some people will buy a trophy asset to say they own it, because they can brag and show it off to their other rich friends. Rich people can afford to lose money. Peter Lynch advocated using the PEG ratio for choosing stocks. A PEG of 2 is good, 1.5 is okay, less than 1 is poor. PEG - (long term growth rate + dividend yield) / PE ratio Railroads were used as an example of a low growth industry with great investors returns. I was puzzled when Warren Buffett bought a railroad company, but now I understand. It was a power value move. That’s why he’s rich and I’m not. Lessons from the Bubble
- Valuations are critical
- Never fall in love with your stocks
- Beware of large, little-known companies
- Avoid triple digit P/E ratios
Technology and Competition Technology and competition aren’t good for investors. It leads to a race toward the bottom. I can think of things being commoditized like online payments, flash memory, etc. The profit margins get squeezed and you need to keep throwing money at technology to keep up. Peter Thiel says that you want to be a monopoly to make money, which means no competition. Section 162(m) of IRS Code Congress said that companies can’t deduct compensation over $1M from taxes since the public were angry that executives got paid a lot. Options were exempt from this. So executives got options instead and made a lot more money from their compensation package. The public and Congress dissatisfaction of executives making a lot of money lead to executive making even more money. This also misaligned incentives between executives and investors. Whether options should be expensed or not is under debate. Putting options in the expense column lowers earnings. Dividends are harder to fake than earnings. Baby Boomers
As parents with sons and daughters in college already know, instead of being the prized assets that Adam Smith wrote about in 1776, children can become expensive burdens.
What happens when all the baby boomers retire? If you’re holding a stock, in order to sell it, you need a counter party. When baby boomers retire, they will be offloading their stocks, but will there be enough people to buy them? This could cause prices to crash. Fortunately, this won’t happen, because even though developed countries like the US and Japan are aging, the world is not. Large developing nations like China and India will start acquiring US assets. This is what happened when Lenovo bought IBM’s computer division. This is only the beginning. For the baby boomers to retire, we need to keep selling assets to China. When baby boomers move to Florida to retire, they will sell their expensive Palo Alto homes to people in China. D-I-V Directives
- Dividends - Buy stocks that have sustainable cash flows and return these cash flows to the shareholders as dividends.
- International - Recognize the forces that will swing the balance of economic power away from the United States, Europe, and Japan toward China, India, and the rest of the developing world.
- Valuation - Accumulate shares in forms with reasonable valuations relative to their expected growth and avoid IPOs, hot stocks, or other firms or industries that the consensus believes are “must-have” investments.