Stocks For The Long Run - Principles

Principles

The data below is taken from Table 1.1, 1.2, Fig 1.5 and Fig 6.4 in the 2002 edition of the book.

Key Data Findings: annual real returns
Duration Stocks Gold Bonds Dividend Yld Inflation rt Eqity Prem Fed Model
1871–2001 6.8 -0.1 2.8 4.6 2.0 0–11 NA
1946–1965 10.0 -2.7 -1.2 4.6 2.8 3–11 NA
1966–1981 -0.4 8.8 -4.2 3.9 7.0 11–6 TY
1982–2001 10.5 -4.8 8.5 2.9 3.2 6–3 YT>=EY.

This table presents some of the main findings presented in Chapter 1 and some related text. Stocks on the long term have returned 6.8% per year after inflation, whereas gold has returned -0.4% (i.e. failed to keep up with inflation) and bonds have returned 1.7%. The equity risk premium (excess return of stocks over bonds) has ranged between 0 to 11%, it was 3% in 2001 also. The Fed model of stock valuation was not applicable before 1966. Before 1982, the treasury yields were generally less than stock earnings yield.

Why the long-term return is relatively constant, remains a mystery.

The dividend yield is correlated with real GDP growth, as shown in Table 6.1.

Explanation of abnormal behavior:

  • The low stock return during 1966–81 (and high gold return) was due to very high inflation.
  • The equity risk premium rose to about 11% in 1965, however that should be unsustainable over a very long term.

In Chapter 2, he argues (Figure 2.1) that given a sufficiently long period of time, stocks are less risky than bonds, where risk is defined as the standard deviation of annual return. During 1802–2001, the worst 1-year returns for stocks and bonds were -38.6% and -21.9% respectively. However for a holding period of 10-years, the worst performance for stocks and bonds were -4.1% and -5.4%; and for a holding period of 20 years, stocks have always been profitable. Figure 2.6 shows that the optimally lowest risk portfolio even for a one-year holding, will include some stocks.

In Chapter 5, he shows that after-tax returns for bonds can be negative for a significant period of time.

Key Data Findings: annual real returns
Duration Stocks Stocks after tax Bonds Bonds after tax
1871–2001 6.8 5.4 2.8 1.8
1946–1965 10.0 7.0 −1.2 −2.0
1966–1981 −0.4 −2.2 −4.2 −6.1
1982–2001 10.5 6.1 8.5 5.1

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