Tags: spetrino growth trap victim

Don't Fall Victim to the Growth Trap

By Bill Spetrino   |   Tuesday, 05 Jan 2010 02:55 PM

Wharton professor Jeremy Siegel, who has done extensive research on investing, has argued that investors seeking exciting new technologies underperform boring, proven dividend-paying companies.

Need proof? Siegel went back and looked at the top 50 companies in 1950. For a 50-year period, a $10,000 investment in each of the 50 top companies with dividends reinvested you would have nearly $630 million compared to the $110 million in a stock market index fund.

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Still not convinced?

IBM should have done well from 1957 to 2003, given the rise in technology in that time period. Ten thousand dollars invested would have gotten you 13.83 percent with reinvested dividends or about $9.61 million, which is not bad.

However, stodgy old Standard Oil would have returned you 14.42 percent when factoring reinvested dividends, or more than $12.6 million.

Two major things should resonate here:

• An extra 0.59 percent over 46 years is worth almost $3 million, so raising your annual returns a few percentage points matters.

• Although IBM grew their earnings faster than Standard Oil, the investor in IBM performed worse because he was paying a higher multiple for the higher growth stock and for the shares purchased with the reinvested dividends.

Investing in the highest dividend-paying stocks did not yield the best results. Investing is 50 percent art (instinct) and 50 percent science (numbers) and those who bought high-dividend stocks that cut or eliminated their dividends are akin to the rat in the trap that decided he no longer likes cheese.

Siegel says the three traits for the best performing stocks are:

• a slightly higher PE ratio than average (but none of the firms had an average PE over 27 times earnings)

• an average but steady dividend and

• much higher than average long term earnings growth

The problem is as many academicians like Siegel is that forecasting the third number — future earnings growth — is not an exact science, and it separates the “number cruncher” from the real investor. An investors’ return would be maximized if he could have the discipline and to wait for the proper entry point on the stock based on his estimate of earnings.

In this supposed lost decade where the Dow is lower than it was 10 years ago. those of us like myself who understand how to combine Siegel’s three traits and then get the proper entry point, and who can best judge the risk-reward ratio, averaged more than 18 percent compounded annually.

Combining compounded interest with the reinvestment of dividends has helped me build a dividend stream that covers all my family’s annual living expenses.

Sound interesting? Click on the link below for more...

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