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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%

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
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

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

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

International

Buy stocks that have sustainable


cash flows and return dividends
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

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