A look at some numbers
In recent times there have been multiple references to the study Jeremy Siegel did on the long term returns of the Nifty 50 of 1972. The general argument given is that as a group, despite starting with an average PE of about 42, they have returned almost as much as the S&P 500, so it wasn't so bad to buy and hold them.
I disagree. Almost nobody was going to buy all 50 stocks. And what do we see when we look at the actual distribution of returns? Out of the 50, 15 beat the S&P 500 over the next 25 years. Number 16, J&J, matched. Consider some recent numbers that Berney has shared with us:
Morningstar's Stocktools has extensive information on more than 7,600 companies. Consider the following extremely relevant information:
Of the investment universe of 7,486 companies that have 1 year stock performance, 37.0% (2,770) beat the Index, 29.4% (2,203) provided a return between 0% and the Index, and 33.6% (2,513) had a negative investment return. Of the investment universe of 5,925 companies that have a 3 year stock performance, 30.5% (1,807) beat the Index, 42.7% (2,532) provided a return between 0% and the Index, and 26.8% (1,586) had a negative investment return. Finally, of the investment universe of 4,373 companies that have a 5 year stock performance, 32.5% (1,423) beat the Index, 43.2% (1,887) provided a return between 0% and the Index, and 24.3% (1,063) had a negative investment return. This is in the midst of a raging bull market.
So over this longer period, 30% of the Nifty 50 beat the index - seems about average for me. What are the odds that investors in 1972 (and I doubt many bought all 50) were able to select a subset portfolio that would beat the market? Of the 15 companies whose stocks outperformed the market, seven were pharmaceuticals. The next best-represented group was consumer non-durables, such as KO, PEP, G, and PG.
I don't know what today's Nifty 50 is, but I'm willing to bet it includes KO, G, MSFT, and CSCO. I've read numerous arguments that KO has outperformed the market for decades, and that it could have been valued much higher in 1972 and still outperformed relative to the market since. True, but let's take another look at that, thinking about investor psychology. During the bear market, KO's stock lost 75% of its value. It was over a decade before it returned to its 1972 value. Would you be willing to see a stock lose 75% of its value and then take over a decade to get back to the break-even point?
Valuation does matter. Even for the greatest companies.
What is kind of funny is to read how this market isn't overvalued by comparison to the Nifty 50 of 1972. C'mon, writers of the popular press. Compare today's Nifty 50 to the Nifty 50 of 1972 or compare the S&P 500 of today to the S&P 500 of 1972. And now we have Abby Cohen saying that at current levels the S&P 500 is undervalued - with her forecast of 5-6% earnings growth. At what point then does it become overvalued?
And the rest of the market? I read how the average stock has lost 20-40% since the start of 1998. Therefore they are in a bear market and must be undervalued. Maybe. But if a stock is overvalued by 50%, and then loses 20%, it is still overvalued by 20%.
Axel
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