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History shows stocks still king for long-term investing

Dan Richards is president of Strategic Imperatives. He is a faculty member in the MBA program at the Rotman School at the University of Toronto. He also hosts a weekly conference call called Monday Morning Jump Start, which is about strategies for financial advisors. Advisors can see it He can be reached at

A phrase popularized by U.S. president John Kennedy was from Spanish philosopher George Santayana: "Those who fail to learn from the lessons of history are doomed to repeat them."

That's true when it comes to geopolitics - and equally true when it comes to investing.

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The premiere name in investing history is Jeremy Siegel of the Wharton School in Philadelphia, whose 1994 book Stocks for the Long Run is regularly cited among the all-time Top 10 books on investing.

Mr. Siegel rigorously studies investment history without any preconceptions - and then draws conclusions based on what the facts tell him. And his mindset isn't cast in stone; if the facts change, his conclusions change.

It's for this reason that in mid-September I travelled to Philadelphia to talk to Mr. Siegel and his colleagues at Wharton, considered the world's top finance faculty.

Here are four key points that emerged from that talk:

Stocks still make sense in the long run

Before writing Stocks for the Long Run, Mr. Siegel painstakingly assembled almost 200 years of U.S. market data on stocks, bonds, Treasury bills and gold. His conclusion was clear: Over the long run, stocks have outperformed every other asset class by a lot.

The price for that outperformance, of course, is short-term volatility - something investors were reminded of last year. Mr. Siegel certainly cautions investors who need their money in the short or mid-term about over-committing to stocks. But for investors with a time frame of 15 years or longer, Mr. Siegel has found that stocks deliver substantially superior returns with less volatility than bonds.

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When asked about the past 10 years, among the worst on record for stocks, Mr. Siegel said he recently revisited his data. His conclusion: Even with the disappointing performance of the decade, stocks have still served long-term investors substantially better than any other investment.

It's all about valuations

In 2005, Mr. Siegel published a follow-up book The Future for Investors: Why the Tried and the True Triumph over the Bold and the New. His conclusion: The single factor that drives investor success is not picking winning firms, but rather the entry points at which firms are purchased.

Mr. Siegel looked at the Top 50 U.S. companies by market value in 1950 and studied returns to 2003.

The three that provided the best returns were Kraft Foods, RJR Reynolds and Exxon Mobil - not high-flying New Economy firms but rather dull, comparatively boring, Old Economy businesses.

The reason they outperformed was not that they were great compared to the rest, but rather that their purchase prices represented superior value.

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Warren Buffett has stated that he would rather buy a wonderful company at a fair price than a fair company at a wonderful price. While Mr. Siegel and Mr. Buffett agree on many things, they differ on this issue - to maximize returns, a wonderful price for a solid company is paramount.

Beware of the growth trap

Related to his point about valuations, from his analysis of historical data Mr. Siegel has identified something he calls the growth trap - investors have a tendency to fall in love with fast-growing companies and pay too much for them, depressing long-term returns. It was because of elevated prices that Mr. Siegel wrote an article in The Wall Street Journal in March, 2000, at the peak of the tech boom, warning that the valuations of these stocks were unsustainable.

Stocks for the Long Run advocated the use of market indexes, using low-cost methods to match the overall market.

In our conversation, Mr. Siegel said he has changed his mind on this issue - he now believes that investors would be better served by emphasizing solid stocks that are attractively valued and excluding faster-growing stocks that have that growth priced in.

Stocks today offer excellent value

Mr. Siegel is firmly convinced that at current prices, U.S. stocks offer excellent value for long-term investors. First, it's his view that today's share prices underestimate the likely recovery in earnings by U.S. firms. Even with the bounce in stock prices since March, he believes that applying conservative valuation measures still leaves stocks undervalued by historical standards.

Second, his research shows that the kind of dramatic drop we saw last year is typically followed by a period of returns that are well above the norm.

When it comes to stock markets, there are, of course, no guarantees. One way to increase your chances of success is to ensure you have the lessons of history working in your favour - and that you look to knowledgeable voices like Mr. Siegel's to shape your thinking in the period ahead.

Special to The Globe and Mail

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