Stocks For The Long Run: Book Notes

This post contains my personal notes and reflections from the book: “Stocks for the long run: 5th edition” by Jeremy Siegel

1. Today’s globalised world warrants higher P/E ratios than in the past. But higher P/E ratios means that average returns in the future are going to be lesser than what they were in the past. But no matter what, stocks will remain the best investment for those seeking steady long-term gains. Why? Equities have to outperform bonds in the long run if our capitalist system is to survive. Bonds are contracts enforceable in the court of law. Equities promise the owners nothing; they involve a high degree of faith in the future. Since they are riskier, they have to have a higher expected return. If the long-term return on bonds were higher than that of equities, then they would priced so that risk will earn no reward. If that happens, the capitalist system will die.Therefore, stocks have been and will remain the best investment for all those seeking long-term gains. Yes, events like the financial crisis of 2008 may test our belief in this, but if we persist, then we will definitely be rewarded.

2.Investing over time in stocks has been a winning strategy whether one starts an investment plan at the market top at not. Even if you had started investing regularly in 1929 when the great stock market crash happened, over the long run( 30 years and above), you would have outperformed all other asset classes.

3. The total real and nominal returns from 1802-2012 for various asset classes are as follows. Total return is capital gains+ reinvestment of interest or dividends back into the same asset class.

  • Stocks: 6.6%(real), 8.1%( nominal)
  • Bonds: 3.6%(real), 5.1%(nominal)
  • Bills: 2.7%(real), 4.2(nominal)
  • Gold: 0.7%(real), 2.1%(nominal)
  • US Dollar: -1.4%, 1.4%(nominal)

4. Stocks have the behaviour of mean reversion: periods of above average returns tend to be followed by periods of below average returns and vice versa. In the short run, stock returns are very volatile driven by earnings, interest rates, risk, uncertainty, optimism, pessimism, fear and greed. But in the long run, they always move upwards. But in the short or even medium term, there can be bumps, even what may be seen as serious ones.

5. Leverage, if not properly employed hurts ultimately. A modern passenger car is safe than one built 50 years ago. But that does not mean the automobile is safe at any speed. A small bump on the road can wreak havoc to the best car. So be careful of  excessive leverage in all forms.

6. In a financial crisis, there is increased correlation among the world stock markets, but on a longer term, the correlations are still low. Therefore it is prudent to diversify when investing for the long-term.

7. No asset class can stay permanently detached from fundamentals, whether it is stocks or bonds.

8. The world is more globalised( in terms of work and who earns and who saves and who consumes) than ever and innovation and invention will continue to happen. Hence it is likely, that over the long run, equities will give us similar historical returns as in the past.

9. If you invest in the stock market and reinvest the dividends and never touch the capital, you can accumulate a lot of wealth. But we always accumulate less, because we spend the dividends or the asset itself. Very few have the patience to wait for generations.

10. Gold hedges inflation but does little else. If you constantly hold gold in your portfolio, your returns are likely to suffer.

11. Although most of the data we have concerns the US stock market, similar findings that stocks outperform bonds over the long run have been shown in many world markets. If we have to believe that capitalism will exist, then stocks should offer the best long-term returns.

12. In the short run, bonds or even bank accounts can outperform stocks. In the long run, stocks usually beat bonds by a great margin. In the long run, investment in stocks also maintain their purchasing power. So, stocks are the best investment for the long run.

13. % of time stocks beat bonds:

  • Over 1 year: 60% 
  • Over 2 year: 60%
  • Over 10 years: 80%
  • Over 20 years:90%
  • Over 30 years: almost 100%

14. All the major stock market indices can be replicated by investors. Therefore there is no statistical reason to believe that these indexes give a biased representation of the return on the market.

15. An investor who purchased the original S&P 500 firms and never bought any of the other firms would have outperformed the updated index over the last 50 years.

16. The tax advantage of equities over bonds is greater over long periods of investment.

17. The price of any stock is always equal to the present value of all future dividends and not the present value of future earnings. Earnings not paid to the investor as dividends can have value only if they are paid as dividends or cash disbursements at a later date. Valuing stock as the present discounted value of future earnings is manifestly wrong and greatly overstates the value of the firm.

18. Gordon dividend growth model: 

Price = Dividend per share/ Required return on equity – Rate of growth of future dividends per share

Required return on equity = Risk free rate + Expected rate of inflation + equity risk premium

19. Operating earnings are more important than reported or GAAP earnings.

20. Earnings yield on stocks is a real yield and should match the average real return that shareholders receive for holding equities.

21. Valuation is useful and one can use many methods. But it is not infallible. For who knows what the future brings. For most of us, holding a diversified portfolio should do just fine.

22. Over the long run: Small stocks outperform long stocks. Value stocks outperform growth stocks. The 100 highest dividend yielders in the S&P 500 outperform the S&P 500. The ten highest yielding Dow stocks also gives a good return.The ten highest yielding stocks from the largest 100 of the S&P 500 stocks also gives a good return. The 100 stocks with the lowest P/E ratio in the S&P 500 outperform the S&P 500. Stocks with lower liquidity outperform those with higher liquidity. IPOs generally underperform.

23. Only investors with a fully diversified world portfolio will be able to reap the best returns with the lowest risk.

24. Stocks are not good hedges against inflation in the short run. In the long run, they are a very good hedge against inflation.

25. You cannot beat the stock market by analyzing real economic activity. Nobody has done it so far.

26. World events may shock the market in the short run but they have been unable to dent the long-term returns that have become characteristic of stocks over the long run.

27. Strong economic growth invariably raises interest rates, but it has an ambiguous effect on stock prices, especially in the late stages of an economic expansion as higher interest rates battle against stronger corporate profits. Higher inflation is bad for both the stock and the bond markets. Central bank easing is very positive for stocks and can lead to good stock rallies. But these are all in the speculator’s realm. Most investors will do well to watch from the sidelines and stick to an investment strategy for the long run.

28. When the market is falling, it is wise to buy more, if you are holding for the long term.

29. Moving average strategies often do not work because of many whipsaws. Short term momentum strategies may work if the costs are low enough and you have to take into account taxes and slippage.

30. Stocks that performed poorly over the previous 3-5 year period significantly outperformed those that had done well over the previous 3-5 year period.

31. Calendar anomalies are not reliable and probably worth the trouble.

32. Futures and options have helped the stocks to be more liquid but are not a good way to get rich over the long run.

33. Precommit yourself to an investing plan and follow it.

34. If you invest when there is a lot of bad sentiment and stocks are falling, you will usually do well over the long run.

35. The best bet is to invest in capitalisation weighted or fundamentally weighted index funds.

36.The following are guides to successful investing:

  • Keep your expectations moderate. Over the long run equities have returned 6-7% after inflation and sold at an average P/E ratio of 15.
  • For long-term investment, invest in stocks.
  • Invest mostly in low-cost stock index funds.
  • Keep at least 1/3rd of your portfolio in non-US stocks.
  • Value stocks have given better return than growth stocks. So overweight value stocks.

36. You can try to pick hot stocks and hot mutual funds. You can market time. You will usually fail. The best bet is to diversify widely and invest for the long run. If you do that, you will be financially comfortable.

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