So today let's discuss why, at least in my view, stocks are likely to be the clear winner with respect to the best investment category for the next five to ten years.
Of course, we can expect many "volatile" valuation bumps along the way, but my ten year crystal ball suggests that more than a double in a portfolio's initial value isn't unlikely.
To add even more to the relative attractiveness of stocks, a beginning dividend yield of ~3% should offset inflation over the ten year time frame. If future cash dividends grow at an annual compound rate of 7% annually, they will double in ten years as well.
In order to restrain this perhaps burst of irrational exuberance, we'll plan to stick with large American based blue chip companies that generate lots of cash, have solid market positions and pay consistent and increasing cash dividends over time.
After the bubble burst in 2001, the past ten years have been a difficult period with flat shareholder returns over the decade, to be sure. Along those lines, 2011 was another generally flat performance.
To me all that's a healthy sign and just means that, in real valuation terms, stocks are roughly 10% less expensive than a year ago. That's because earnings increased ~10% in 2011 while share prices basically remained flat.
So using lots of history as our valuation benchmark, for those with a longer term perspective, stocks of good companies are cheap today.
Here's how one investing bull in Cheap Chips explains the current environment:
"It is the oldest saw in the investment handbook: buy low and sell high. But with global shares at their cheapest in a generation, confident equity investors are a rare breed.
Back in 1999, share buyers were everywhere, clambering over themselves for any old variety of equity – and plenty of the new-fangled dot-coms too. Even a sober investor, one that bought a diversified basket of S&P 500 equities, would have got in at a price in excess of 20 times forward earnings. Now the forward PE ratio is just above 11.
Those that bought in the high old times around the turn of the century have not lost as much as might be imagined. Increases in corporate earnings have cushioned the pain caused by the compression of valuation multiples. And dividend payments have bolstered total returns. The all-in value of a portfolio of $1,000 worth of S&P 500 shares acquired at the turn of the century is now just in the black – in nominal terms – despite the intervening crisis.
A new Breakingviews calculator works out what happens if, over the coming years, valuation multiples rise again. Say an investor buys in at 11 times earnings and sells in five years’ time at the 25-year average S&P 500 PE ratio of 15 times. Meanwhile, suppose companies manage to increase their earnings per share at a 5 percent annual rate. Bears might think that is optimistic – and short term it may be. But the longer term earnings trends suggest this is a modest assumption.
Breakingviews calculator: What price earnings?
Each $1,000 invested now would be worth more than $1,740 in five years. Dividends, currently running at a 2.6 percent yield on the S&P 500, will add an extra fillip. But inflation will reduce the real gain. Assuming 2.5 percent is a reasonable outlook for inflation, that’s roughly a wash with dividends.
As the above pundit points out, investing in stocks is always risky. After all, there's a great deal of turmoil in the world today. But not investing in stocks is risky as well, and perhaps represents the riskiest course of all for one's future financial well being.
Here are a few reasons why the potential rewards of stock ownership outweigh the risks assumed for the foreseeable future.
My belief that during the next ten years stocks are likely to double or more in value is based on several factors. The market's PE multiple (price of a share divided by that company's earnings per share) today is historically low, and it's also inexpensive relative to inflation and interest rates.
The earnings outlook is good, and company balance sheets are very strong. Cash flows are solid, costs are in line, and cash dividends and share repurchases continue to increase. Plus, stocks have done absolutely nothing for the past decade, and there has been a serious reluctance by individual investors to put their money into stocks. Hence, it's past time for a reversion to the mean in terms of valuation. And in company performance as well.
When down the road economic growth resumes at a healthy pace, which it will, company earnings will accelerate quickly. But by then their stock prices will already have increased materially from today's levels. That's the way markets work.
So based on today's share prices, I am convinced that stocks will clearly outperform investment alternatives for the next decade.
The Breakingviews calculator from the above article is easy to use and most helpful when assessing the valuation of the stock market today. You can plug in your own assumptions about the future, but barring a worldwide catastrophe, stocks are cheap.
That's due to the current very low interest rates, low inflation, healthy corporate earnings and a relatively low market PE multiple.
The prospects for gradually better economic times ahead are good as well, so owning stocks during the next decade should work out just fine.
That's my investing resolution. We'll see how it turns out.
Thanks. Bob.
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