Editor's Note: Forget the Thrilla in Manila or Louis vs. Schmeling. Round for round, the most interesting bout we know of is the back-and-forth between Businessweek Chief Economist Michael J. Mandel and author Jeremy J. Siegel. It started when, 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 newfangled ones (see BW, 2/14/05, "Forget the Next Big Thing").
Siegel disagreed with Mandel's criticism, hence Round 1 of their written sparring match ("Debating the 'Growth Trap'"). Round 2 followed ("How to Pick the Tech Winners?"). Now, after catching their breath, they're back in the ring.
Michael, when I read your sentence "When people ask me where they should put their money...I leave them with one word to think about: telecom," I immediately thought of the film, The Graduate, in which an older character's one-word advice to Benjamin Braddock, who had just graduated from college, was "plastics." Plastics stocks did not do well over the last 40 years, and I'm not sure that telecom stocks will do any better in the next 40.
There is no sector that better illustrates the "growth trap" than the telecommunications industry. The advances in telecom created one of the greatest engines of economic growth that I know, and they lay the foundation for the sweeping changes that will take place in the developing world for years to come.
FAT YIELDS. But the technological development was so rapid that the industry created a supply glut, pushing down prices dramatically and devastating profits. Technology guru, author, and telecom enthusiast George Gilder, whose words sent billions of dollars of investment capital flowing in the late 1990s, predicted that telecom firms would battle for worldwide supremacy, but "in a trillion dollar market there will be no losers." In fact, there were almost no winners.
Charlie Munger, Warren Buffett's right-hand man at Berkshire Hathaway (BRK.B), said, "The great lesson in microeconomics is to discriminate between when technology is going to help you and when it's going to kill you. And most people do not get this straight in their heads."
That said, many of the Baby Bells do have fat dividend yields. In fact, 3 of the 10 companies in my 2004 S&P 10 high-yielding portfolio that I recommended in The Future for Investors were Verizon (VZ), BellSouth (BLS), and SBC Communications (SBC). They're all in the 2005 portfolio and currently have yields of more than 4%.
SUPPLY GLUT. The S&P 10 portfolio of high-yielding companies historically has delivered excellent returns to investors, about 4.5% per year above the market. But for investors who go after these high yields, I would recommend doing so in a more diversified high-yield portfolio such as the S&P 10 or the Dow 10.
Moreover, not all telecom stocks are created equal -- some like Qwest (Q) and Nextel Communications (NXTL) pay no dividends at all. Many of these telecom stocks' p-e ratios are not that attractive, especially in light of the supply glut that is depressing pricing power.
The price of the telecom sector is 15.6 times projected 2005 operating earnings, almost exactly the same as the rest of the S&P 500-stock index. But on the basis of last year's reported earnings, telecom is selling at a 36.3 p-e ratio, the highest in the market and almost twice the S&P 500.
GOING INTERNATIONAL. Michael, I agree wholeheartedly that putting money in India and China is high-risk. In Chapter 16 of my book, I indicate that China, the fastest growing country over the past decade, experienced the world's worst returns -- another illustration of the "growth trap." That is why I don't want to overweight the fastest growing countries in a world index.
But investors must go international. The U.S. does not have a monopoly on the "tried and true" companies that I recommend. Firms such as Procter & Gamble (PG), Toyota (TM), and Novartis (NVS) have great opportunities to expand in the developing economies.
Good stock performances will not be limited to firms headquartered in China and India or even the U.S., but to any firm that takes advantage of growing markets and provides trustworthy products. Since more than half of the equity capital is now headquartered outside our country, investors must diversify to take advantage of the coming global growth.
Jeremy, you say that "there is no sector that better illustrates the 'growth trap' than the telecommunications industry." I have to say that I do not understand your definition of a growth sector. From my perspective, a growth sector is one that takes a bigger share of the economy over time.
By that measure, telecom has been the very opposite of a growth sector over the past decade. In 1993 it was 2.6% of the economy -- in 2003, the latest year available, it was still 2.6% of the economy. Given this stagnation, it doesn't surprise me that the performance of telecom stocks was quite poor over this period.
THE BIG MISTAKE. By contrast, the real "growth sectors" had good or even great stock performance. The share of the economy going to amusements, recreation, and gambling greatly expanded from 1993 to 2003. It shouldn't come as any great shock that the casinos and gaming index of the S&P 500 did very well over the same stretch. Similarly, construction took a bigger share of the economy, and the stocks of homebuilders and home-improvement retailers did quite well.
I'm going to suggest two principles: First, a sector that is growing as a share of the economy will demonstrate, more often than not, good stock performance as well. Second, a sector that is adopting a new technology need not grow as a share of the economy, especially in the first few years after the new technology is introduced. That's where investors make their big mistake -- they look at the excitement and assume that it will immediately translate into above-average growth relative to the economy. This is what you call the growth trap.
However, history shows that many technology-driven industries eventually escape the growth trap, taking a bigger share of the economy and showing better stock performance. I think that is what will happen to telecom.
As telecom demand continues to soar, and as the number of competitors falls, businesses and consumers will eventually be willing to fork over a bigger share of their budgets for wireless phones, online music, broadband Internet connections, satellite radio, and a plethora of new services. When that happens, the stocks can only benefit.