“The Future for Investors”

by Jeremy Siegel

“The Future for Investors”

by Jeremy Siegel

Kevin KranzlerLisa Lajeunesse

Ray NgJohn Schmidt

Kevin KranzlerLisa Lajeunesse

Ray NgJohn Schmidt

AgendaAgenda

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

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.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.

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”

Part 1“The Growth

Trap”

The Growth TrapThe 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.

Everyone wants to ‘beat the market’ & invest in the next big thing.

However, as Siegel points out, pursuing returns through growth continually disappoints investors.

ExampleExample

Growth Measures IBM Standard Oil of NJ AdvantageRevenue Per Share 12.19% 8.04% IBMDividends Per Share 9.19% 7.11% IBMEarnings Per Share 10.94% 7.47% IBMSector Growth 14.65% -14.22% IBM

Table 1.1: Annual Growth Rates, 1950-2003

What actually happened?What actually happened?

IBM: $1000 initial investment became $961,000.

Standard Oil of NJ: $1000 initial investment became $1,260,000.

IBM: $1000 initial investment became $961,000.

Standard Oil of NJ: $1000 initial investment became $1,260,000.

How is this possible?How is this possible?

Return Measures IBM Standard Oil Advantageof NJ

Price Appreciation 11.41% 8.77% IBM

Dividend Return 2.18% 5.19% Standard Oilof NJ

Total Return 13.83% 14.42% Standard Oilof NJ

Table 1.3: Source of Returns of IBM and Standard Oil of NJStandard Oil of NJ, 1950-2003

What matters!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!

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

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

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…What Siegel Found…

High P/E stocks earn lower returns and low P/E stocks earn high returns, on average

High P/E stocks earn lower returns and low P/E stocks earn high returns, on average

1957 Initial 2003 Investment Annual RateInvestment 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

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

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

Rank 2003 Name Accumulation Annualof $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%

Top Eight Performing Survivors, 1957-2003

Sector GrowthSector Growth

Investment strategies based on industry/sector are growing in popularity

Morgan Stanley & Goldman Sachs

Investment strategies based on industry/sector are growing in popularity

Morgan Stanley & Goldman Sachs

SummarySummary

Do not be seduced by that hot new company or investors

Overwhelming demand for stocks overvalues those stocks which lowers the return for investors

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”

Part 2:“Overvaluing the Very

Few”

How To Spot a BubbleHow 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

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

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.

“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

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?”

“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

Investing in the Newest of the New

IPO Relative ReturnsIPO Relative Returns

Figure 6.2 Annualized Returns on Yearly IPO Portfolios Minus Returns on Small Stock Index, Returns Measured Through December 31, 2003

Creative Destruction 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

“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 PigsCapital 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

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 RatioCapex Ratio

Success Amongst Failure

Success Amongst Failure

Wal-Mart’s Strategy for Success

Southwest Airlines low cost structure

Nucor Steel use of new technology

Wal-Mart’s Strategy for Success

Southwest Airlines low cost structure

Nucor Steel use of new technology

Winning ManagementWinning 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

“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

SummarySummary

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

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”

Part 3: “Sources of

Shareholder value”

Correlation between Dividends and Returns

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

Higher dividend paying companies provide greater returns

Lower dividend paying companies provide less returns

Not just due to extra cash flow

Dividends to Capital GainsDividends to Capital Gains

Purpose of DividendsPurpose of Dividends

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

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

Importance of Bear marketsImportance 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

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 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

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

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

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 forRed 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

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

SummarySummary

There is a positive correlation between dividends and returns

There are numerous ways to value a company

There is a positive correlation between dividends and returns

There are numerous ways to value a company

Part 4:“The Age Wave”

Part 4:“The Age Wave”

Baby Boomers – Baby BustBaby Boomers – Baby Bust

ProblemsProblems

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

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 ProblemsMore 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+

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 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

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 Possible Solutions

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

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

The Global SolutionThe 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

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 [2]

The Global Solution [3]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

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

SummarySummary

Baby boomers retirement poise a difficult transition period for investors

Investors must seek a global solution

Baby boomers retirement poise a difficult transition period for investors

Investors must seek a global solution

Part 5:“Portfolio Strategies”

Part 5:“Portfolio Strategies”

Global Market TrendsGlobal Market Trends

Growth Prospects in China & India Growth Trap

Example: Brazil vs. China

Emerging Chinese Economy Home Equity Bias Correlation of US & World markets

Growth Prospects in China & India Growth Trap

Example: Brazil vs. China

Emerging Chinese Economy Home Equity Bias Correlation of US & World markets

World PortfolioWorld 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

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 ToolsGlobal Investment Tools

MSCI EAFE Index Dow Jones Wilshire Total

Stock Index Vipers Spiders Cubes

Diamonds

MSCI EAFE Index Dow Jones Wilshire Total

Stock Index Vipers Spiders Cubes

Diamonds

MSCI EAFE IndexMSCI EAFE Index

Future StrategiesFuture Strategies

Future is bright for investors Growth in emerging markets Future stock performance

Stocks to purchase Initially broadest index possible

D-I-V Directives

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 DirectivesD-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

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, 1957-2003Table 17.4 Valuation Strategies, 1957-2003

SummarySummary SummarySummary

Overall Book ReviewOverall 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

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