Recently, I began to read Jeremy Siegel’s new book, The Future For Investors: Why the Tried and True Triumph Over the Bold and the New. As you can imagine, I’ve read a lot of finance, accounting, investing, business, and management books in my life as well as written one myself. It is no exaggeration to say that I think Siegel’s most recent treatise may be one of the most important books penned on the topic of portfolio management in the past twenty years. If you don’t already have a copy, get one immediately (after you finish reading this article, of course!).
The premise of his work is simple: Over time, firms that return excess capital to their owners – the shareholders – in the form of cash dividends and share repurchases soundly trounce those that pour every excess dime back into core operations to fund growth. Investors often fail to notice because they are looking for “action” in the form of a rapidly rising share price or market capitalization, forgetting that the total growth of the investment must include cash paid out to the owners along the way. While this may seem counterintuitive, throughout the three hundred page work, the professor walks you through historical statistics and research that will leave even the most hardened critic convinced that the path to riches may lie along the most boring, gentle road.
A Surprising StatisticPerhaps the most convincing fact: Between 1950 and 2003, IBM grew revenue at 12.19% per share, dividends at 9.19% per share, earnings per share 10.94%, and sector growth of 14.65%. At the same time, Standard Oil of New Jersey (now part of Exxon Mobile) had revenue per share growth of only 8.04%, dividend per share growth of 7.11%, earnings per share growth of 7.47%, and sector growth of negative 14.22%.
Knowing these facts, which of these two firms would you have rather owned? The answer may surprise you. A mere $1,000 invested in IBM would have grown to $961,000 while the same amount invested in Standard Oil would have amounted to $1,260,000 – or nearly $300,000 more - even though the oil company’s stock only increased by 120-fold during this time period and IBM, in contrast, increased by 300-fold, or nearly triple the profit per share. The performance differences comes from those seemingly paltry dividends: Despite the much better per share results of IBM, the shareholders who bought Standard Oil and reinvested their cash dividends would have over 15-times the number of shares they started with while IBM stockholders had only 3-times their original amount. This also goes to prove Benjamin Graham’s assertion that although the operating performance of a business is important, Price is Paramount.
The Basic Principle of Investor ReturnsAnother fundamental concept Siegel defines in the book is something he called the basic principle of investor returns, namely, “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 excepted.” This, he says, explains why firms such as Philip Morris (renamed the Altria Group) did so well for investors (in fact, the tobacco giant was the single best investment of all large stocks from 1957 to 2003, compounding at 19.75% with dividends reinvested, turning a $1,000 investment into $4,626,402!).
The implications for his argument are enormous and echo those of Benjamin Graham decades ago. In essence, it doesn’t matter to an investor if he buys a firm growing at 20% if that growth is already priced into the stock. If the company turns in results that are lower – say 15% - the odds are substantial that the stock will get hammered, dragging down returns. If, on the other hand, you bought a firm that was growing at 10% but the market expected 5%, you would experience much better results. At the end of the day, the only thing that matters is how much money you have (or as Warren Buffett once remarked, how many hamburgers you can purchase). Many investors forget that the way to riches is to buy the most earnings for the lowest price which is often not the company expanding at the most rapid rate.
Share Repurchases vs. Cash DividendsThe book also discusses this topic, which we examined in depth in last week’s article Cash Dividends vs. Share Repurchases.