Equities Are Dead (Again)

In August 1979, following a decade of high inflation and a shaky stock market that led to depressed investor sentiment, BusinessWeek magazine published a now-famous cover declaring "The Death of Equities."

What made the cover famous -- in hindsight, of course - was what has happened in the share market in the decades hence.

Date S&P 500 Value Total Return Since August 1979 Annualized return
August 1989 349.84 220% 12.4%
August 1999 1,348.27 1,136% 13.4%
August 2009 1,028.93 844% 7.8%

 Source: Yahoo! Finance. Does not include dividends.

As it turns out, equities weren't dead at all -- investors were just leaving them for dead -- and August 1979 was precisely the time to have put money to work in equities.

In fact, $1,000 invested in the Vanguard S&P 500 Index fund on Aug. 29, 1979, would be worth approximately $7,200 today, not including reinvested dividends. Not a bad return, even with the poor market performance over the last decade.

Long live equities
Today, investors seem to be leaving equities for dead once again, following another poor decade for stocks on top of ongoing economic uncertainty.

Indeed, investor enthusiasm for shares may be near a generational low point. A Prudential Financial survey this spring (prior to the recent market downswing, mind) found that almost three out of five individual investors have lost faith in the stock market, and 44% say they'll never invest in stocks again. Following the dot-com bust, investors may have been once bitten, twice shy, but after another large market plunge during the financial crisis, many investors may have simply thrown in the towel.

Adding to this point, unlike with previous stock market recoveries, as Jason Zweig of the Wall Street Journal aptly noted in a recent article, investors didn't come pouring back into equities even after the market doubled in the 12 months following March 2009. Now, investors chasing performance is normally as reliable as dogs chasing cats, so investor apathy following a period of high returns seems to be telling us that investor interest in equities is rather low.

Even some professional investors, who are often considered the "smart" money in the market, have capitulated. Another recent Wall Street Journal article, for instance, consulted a number of financial planners to find out what they're doing with their clients' money in this market. The responses were, let's just say, rather un-Foolish. Here are three examples:

  1. "Three weeks ago, I would have said: 'We're in it for the long haul' ... But we don't want to see these $200,000 to $300,000 swings in performance in a $5 million account."
  2. "Stocks that have a 5% dividend are great, but what kind of consolation is that going to be if they're down 10%?''
  3. "While [cash] might not be earning anything ... that cash at least isn't losing value.''

Yikes. I'm just happy none of these guys is advising anyone I know.

Stay the course
Admittedly, it's far more difficult to retain a long-term focus when your share prices are falling.

Why might that be? One reason could be our natural propensity for loss aversion. As Legg Mason's Michael Mauboussin noted in this interview, "We tend to suffer two to two-and-a-half times more from the loss than we enjoy the gain." In other words, the fear of further short-term losses often outweighs the knowledge that there's also potential for long-term gains. It's this anxiety that can shorten our mental time horizons and can lead to poor long-term decisions.

It's healthy to question and refine your strategy, of course, but it's also critical to stay consistent. To me, that means buying good companies trading at meaningful discounts to their fair value and then being patient with them, regardless of what may be going on in the market.

That's why I came up with this list of seven companies that deserve a spot on your watchlist today. Each of them exceeds the following criteria and appears to have good competitive advantages alongside healthy financials:

  • Free cash flow/sales above 5%
  • Return on equity over 12%
  • Interest coverage ratio (EBIT/interest expense) above 5 times
  • Net income margin above 15%
  • Dividend yield above 2%

Company

Dividend Yield

P/E Ratio

Intel (NAS: INTC) 4.2% 9.1 times
Philip Morris International (NYS: PM) 3.7% 16.1 times
Medtronic (NYS: MDT) 2.8% 11.9 times
McDonald's (NYS: MCD) 2.7% 18.2 times
Colgate-Palmolive (NYS: CL) 2.7% 17.9 times
Coca-Cola (NYS: KO) 2.7% 12.9 times
Norfolk Southern (NYS: NSC) 2.6% 13.8 times

Source: Capital IQ, a division of Standard & Poor's, as of Aug. 25, 2011.

To me, all these stocks meet the standard of good companies trading at reasonable valuations. Having such a list of high-quality ideas ready (alongside some cash, of course) can help you quickly pounce when other investors are seeking shelter.

Foolish bottom line
All this is to say that general investor sentiment -- from professional and non-professional investors alike -- has once again turned against equities. If history is any indication, that could mean today is a great time to be a contrarian and put money to work in high-quality companies.

Want some more dividend ideas? Click here for a free report from Motley Fool expert analysts: "13 High-Yielding Stocks to Buy Today."

At the time this article was published Todd Wenning is advisor of Motley Fool UK Dividend Edge. He owns shares of Johnson & Johnson and Intel. The Motley Fool owns shares of Philip Morris International, Medtronic, Intel, and Coca-Cola, along with calls on Intel. Motley Fool newsletter services have recommended buying shares of Intel, McDonald's, Philip Morris International, and Coca-Cola, as well as creating a diagonal call position in Intel. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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bdyftns

$1,000 investment and a $ 7,200 return 32 later is pretty lame. Not to mention what the price of goods and services (and gas) were in 1979 and what they are today.

August 26 2011 at 6:44 AM Report abuse rate up rate down Reply