Editor's Note: For those who haven't been following the drama between Businessweek Chief Economist Michael J. Mandel and author Jeremy J. Siegel, here's a recap. In reviewing Siegel's book, The Future for Investors: Why the Tried and the True Triumphs Over the Bold and the New, Mandel gave mostly praise but took issue with Siegel's belief in valuing old reliable investments over more-newfangled ones (see BW Online, 2/14/05, "Forget the Next Big Thing"). Siegel disagreed with Mandel's criticism, hence Round 1 of the written sparring match between them (see BW Online, 3/29/05, "Debating the 'Growth Trap'"). Here's Round 2.
Michael, I don't deny that there were some very big technology winners in the past. The problem for investors is how to determine, in advance, which of these stocks will succeed. At the same time that investors bought Oracle (ORCL), Dell (DELL), or Cisco (CSCO), analysts were also touting Wang Laboratories, Computervision, and Storage Technology (STK) -- all companies with great promise but disastrous returns.
That's why I went back to examine the returns on all of the nearly 9,000 new companies that have gone public over the last 35 years. Many of them come from technology, and other high-growth, sectors. Their returns are very poor. Only one in five of these IPOs outperformed the market in the long run, and almost half of them underperformed the averages of more than 10% per year. In the period from 1968 to 2000, there were only four years in which a portfolio of IPOs did better than the market. In 28 years, they fell behind.
HOT ASIAN MARKETS? Even the big winners, such as they ones you mentioned [in our last debate], were unable to overcome the myriad of losers floated in the same year. Had you invested $1,000 in Intel (INTC) in 1971, the year it went public, it would have grown to $1,887,288 by the end of 2003. But even with that superstar, a portfolio of all IPOs issued in 1971, including Intel, would have fallen behind the market. The same can be said of 1990, the year Cisco, one of the most successful IPOs in history, went public.
Despite our differences on technology stocks, I believe we are not so far apart. First, we both agree that technology is essential for future growth and is the critical factor raising our standard of living. By all means, we should encourage technological advances. And I, like you, also find the pharmaceutical sector very attractive for the long run.
However, my definition of growth is much broader than technology. It encompasses the penetration of well-known consumer brand-name products into the global economy. If Pepsi (PEP), Coke (KO), Procter & Gamble (PG), or Tiffany (TIF) can successfully tackle the Indian and Chinese markets, they could grow as fast or faster than technology stocks for decades to come, despite selling very "nontech" products and using distribution methods not much different from those that they have successfully employed in the past.
PORTFOLIO TRINITY. But to produce a good return, any company, be it tech or nontech, must sell at a reasonable price. I found that growth accounts for only one-third of the return to investors, while valuation accounts for the other two-thirds.
In the book, I looked at my data regarding the winners of the last half-century and tried to distill the information into principles that investors could use to structure their portfolios. The three principles were:
1. a high allocation to international stocks
2. good dividend yields -- although I made an exception for Warren Buffett and Berkshire Hathaway (BRK.B)
3. reasonable price-to-earnings valuations.
Following these strategies gives investors a very good chance of outperforming an indexed portfolio.
Mike, what criteria would you suggest that investors follow when structuring their stock portfolios for these great global shifts that will occur over the next several decades?
Jeremy, I'm going to address your last question first. When people ask me where they should put their money, the first thing I tell them is that I don't do individual stock picks.
But these days, I leave them with one word to think about: telecom.
TELECOM HANG-UPS. The telecom sector these days is a historical anomaly. On the one hand, it's clearly the leading-edge sector technologically. Wireless and broadband together are transforming people's daily lives.
On the other hand, despite the technological advances, telecom's share of the economy remains no higher today than it was 10 years ago. That explains why telecom stock prices have shown such poor returns over the past decade.
But if telecom's share of the economy starts to rise -- as seems likely, based on historical precedent -- the stocks of telecom providers could turn into potential winners. They're technology-driven, which I like. And most of them have high dividend yields and reasonable price-to-earnings valuations, which you like.
OVERSEAS RISK. If we have a telecom boom -- which does not seem at all unreasonable to me -- the benefits could also spill over to telecom equipment providers, cable companies, and all the other companies in the telecom firmament.
Now let's look at the other points that you make. You say that a portfolio of all IPOs issued in 1971, including Intel, has underperformed the market. I'd be interested to know whether the same was true for the set of all technology IPOs issued in 1971 -- where "technology" is broadly defined to include medical as well as information-technology companies.
As for international investing: I think you forget that, for a company or an investor, putting money into China or India represents a high-risk, high-return proposition. The state of the Chinese financial system, in particular, lies shrouded in mystery. That lack of transparency alone is disturbing, but so are the big debt loads and apparent speculative investments.
I'm actually surprised that you're so intent on pushing investors to look overseas, given the underlying theme of your book. The subtitle reads Why the Tried and True Triumphs Over the Bold and the New, but you seem to favor "bold and new" countries such as China and India, rather than "tried and true" countries such as the U.S. Or am I misinterpreting your arguments?