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Siegel's Rule

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May 15, 2005

Siegel's Rule

Michael Mandel

I've been having a debate with Jeremy Siegel about his new book, The Future for Investors. In the latest round, Siegel did some interesting new calculations which show that companies in the S&P 500 with 5-year revenue growth in the lowest quintile tend, on average, to have higher returns than the market.

So "Siegel's Rule" (my term, not his) for investment would suggest that it's a good idea to rank the companies in the S&P 500 by revenue growth over the past 5 years, and then put more money into those companies in the bottom quintile of revenue growth. Today, such companies would include such names as Lucent, Merrill Lynch, and Merck.

If there's interest, I can come up with a longer list of companies with low revenue growth over the past 5 years.

12:17 PM


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Siegel's rule looks disturbingly like the basic statistical effect called "regression to the mean", which describes the fact that if you look at a bunch of sample variables from a population which change over time, each one is most likely to tend towards the mean of population. Siegel might also re-run his statistics on the top quintile and find that they tend to have lower returns than average.

If Siegel's rule is really just regression to the mean, I don't think it would be wise to take it as investment advice. If each stock follows a random walk, then the future performance of every stock is totally unpredictable regardless of where it ranked relative to other stocks. Yet even in this fully random scenario the regression to the mean will still happen. The key point is that the mean itself (The Market Average, in this case), is not fixed. Therefore, just because the lowest quintile of stocks moved up, on average, relative to the upper 4/5 of the market does not mean that they moved up in absolute terms. It is just as likely that the market average moved down to meet them.

A simpler way to state it is that a change in ranking of a given stock does not indicate changes in the actual value of that stock, and Siegel's rule only describes changes in ranking.

Posted by: Dave at May 16, 2005 10:45 PM

Reprinted from Bill Staton's E-Money Digest

"The current Business Week on page 151 has an article on "Undiscovered Funds Worth Noting," nine of which are listed along with their one- and five-year annualized returns. We think it's interesting that six of the nine don't even have a five-year record, but of the three that do, their respective returns are 9.3%, 5.2% and 6.6%. That compares with 15.02% for America's Finest Companies [see Bill and Mary $taton'$ E-Money Digest Clear-Cut Advice for Investors?]over the same period. We think it's worth noting that these funds aren't worth noting.

I don't know about you, but my money's on Bill's picks !!

Posted by: David Bowling at June 14, 2005 04:18 AM

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