VALUE INVESTING IN INDIA

for example, the earnings stream of newspaper publisher Gannett Co., in which Buffett bought a minority stake in 1994. Buffett paid approximately $24 (split adjusted), or 16 times earnings, for 4.9 percent of Gannett's shares. At the time, 30-year bonds yielded 7.8 percent. Buffett's returns, compared to a 30-year government bond, have been exceptional (see Figure 5-3). Buffett, in fact, was willing to pay a premium for Gannett, based on the fact that Gannett's earnings yield would quickly surpass the yield on bonds. Going forward, analysts were projecting that Gannett's earnings would grow at nearly 13 percent annual rates. Thus, Gannett offered Buffett a compelling earnings stream, especially after bond yields fell to around 6 percent in late 1997.

Not surprisingly, Gannett's stock rose by more than 150 percent in the three years subsequent to Buffett's purchase. By early 1998, newspaper properties such as Gannett had been bid up to between 20 and 25 times

One way to think about valuations is inverse of 10 Yr bond rate + certain premium; 12.5x plus 4 x i.e. 16.5 x

Best regards,

Chaitanya

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"Coca-Cola Co. After a steady climb to near $150 per share by late 1972 and then holding within a fairly tight trading range during the brutal decline of 1973 in the $130 to $150 range, Coke finally fizzled with the market in 1974, proving that even some of the bluest of the blue chips eventually fall when markets sell off hard.Near the end of 1973 Coke was selling off as high weekly volume escalated. By early 1974,Coke was down to near $110. The selling really hit home in late summer and fall of 1974 as institutions were unloading the stock. By year-end 1974 Coke was trading near $50 per share. This example alone should be a lesson to all that believing any stock to be immune
to declines due to its reputation no matter what is happening in the market is a dangerous mind-set.We’ve seen others in prior market periods (RCA, Xerox, etc.), and we’ll see others in future cycles (Cisco, Lucent, etc.) that were thought to be immovable on the downside prove to be just like all other stocks — they tend to move with the market, even if they sometimes seem to delay the inevitable"

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W ith the Dow approaching 9000, many a strategist has trotted out the cautionary tale of the Nifty Fifty, those beloved stocks of the early 1970s that came crashing back to earth in the bear market of 1973-74. Just as Microsoft and Gillette number among today's highflyers, back then members of the Nifty Fifty such as Avon Products ,Polaroid , McDonald's and Walt Disney flew way above the rest of the stock market. In fact, some of Nifty Fifty were changing hands at 70-90 times earnings, and value investors have long viewed the Nifty Fifty's subsequent swoon as proper retribution for unbridled excess in the marketplace.

But now comes a revisionist view of that bygone era. Jeremy Siegel, a Wharton School professor at the University of Pennsylvania, has just released a new edition of his book, Stocks for the Long Run, and in it he calculates that an investor who bought the Nifty Fifty at their seemingly ridiculous highs in December 1972 and held them for 25 years did roughly as well as those who simply bought the S&P 500. To Siegel, this performance shows the enduring value of high-quality growth stocks. "You can look at the original Nifty Fifty two ways: Either the prices were crazy-high in 1972, or in the subsequent bear market, people panicked and the stocks got very undervalued. I believe the second view is closer to the mark," Siegel says.

The Original Nifty Fifty Revisited | The New Nifty Fifty

Warren Buffett made a similar point recently in Berkshire Hathaway 's annual report when he wondered whether the attractive prices of the past, not the full prices of today, "were the aberrations."

Siegel's findings are especially relevant now because they come at a time when many investors are straining to find historical comparisons for the current bull market, in which stocks, by most measures, are pricier than ever. Among the stocks behaving like the Nifty Fifty of yesteryear are Pfizer , Coca-Cola , Microsoft, and Gillette, all of which command sizable premiums to the record-high 25 price-to-earnings ratio of the S&P 500. Coke, for instance, trades at 52 times its 1997 operating profits, about double the P/E of the S&P.

As the accompanying table shows, the Nifty Fifty returned 12.7% annually (including dividends) in the nearly 25 years between December 1972 and June 1997. That's just a bit behind the 12.9% return on the S&P 500. And the gap wouldn't be much different if the returns were carried forward until today.

Siegel figures the Nifty Fifty were just 3% overvalued in December 1972 and that they then entered a more than decade-long period of significant undervaluation. The low point relative to the S&P came in 1980, when oil and natural-resource stocks were topping the market.

At their height in late 1972, the Nifty Fifty traded at an average of 41.9 times their earnings in that year, more than twice the multiple of the S&P, which was then 18.9. The Nifty Fifty also were known as "one-decision" stocks because the companies had such outstanding prospects that it was argued an investor never needed to sell them. A reporter for the New York Times, Burton Crane, wrote these famous words at the time:Xerox 's multiple not only discounts the future but the hereafter as well.

"There are some disquieting parallels between now and then," says John Neff, the former manager of Vanguard's Windsor fund. Neff points out that investors once again are paying high multiples of earnings for companies like Procter & Gamble , even though such companies are expected to deliver profit growth that's only in the low double digits.

"Look at Gillette and Coke. They aren't sparkling unit growers, but look at the multiples," Neff says. He notes that the high-teens growth anticipated for Gillette and Coke assume continued improvement in profit margins, adding, "you can't improve margins in perpetuity."

Neff wonders how Coke will be able to crank out 17% growth in earnings per share when the amount of soda it is selling each year is rising by only 7%. He contends that investors buying the current Nifty Fifty at today's high levels might get hurt in a stock slide and have to wait years to get even again.

Nonetheless, many observers maintain the stock market today is considerably healthier and less stratified than it was in the original Nifty Fifty era. "Back then, there was an intense narrowing of the market. There were fewer and fewer stocks holding down the fort," says Charles Pradilla, strategist at Cowen & Co., who was around in the Nifty-Fifty market and in earlier periods of enthusiasm for growth stocks. "It's a different situation now. The market is broadening as it goes up."

Although the two eras may not be comparable, in 1995 Morgan Stanley came up with a new Nifty Fifty index that featured many large, high-quality growth companies, as well as some oil and financial issues. In a sign of the staying power of great companies, there's considerable overlap between the Nifty Fifty of the 1970s and those of today.

Bulls argue that today's Nifty Fifty simply aren't as expensive relative to the S&P 500 as their precursor was in 1972. As noted on the accompanying table , the new Nifty Fifty carry a price-to-earnings ratio of nearly 25 based on projected profits for the next 12 months, versus a P/E of 23 for the S&P.

"Anyone worried about Microsoft's multiple ought to look at the P/Es of 1972 or the early 1960s," Pradilla says. Microsoft, one of the most expensive big stocks in the market, surged seven points last week after the company signaled another stronger-than-expected quarter. It now trades at 88, about 48 times projected calendar 1998 profits and 56 times 1997 calendar earnings.

Back in 1972, the most favored of the Nifty Fifty, Polaroid, fetched 95 times earnings. Disney and McDonald's sported P/Es of 71, and many lesser companies like Digital Equipment , Black & Decker and Kresge (now Kmart ) had P/Es of around 50.

It's true that buyers of the original Nifty Fifty ultimately fared well, but they would need plenty of fortitude to stick with these stocks during the lean years. Avon and Polaroid saw their prices fall more than 80% during the 1973-74 bear market, with Avon not topping its 1972 high until last year. After the crash, it took Coca-Cola more than a decade to get back to its 1972 peak, while Burroughs (now Unisys ) has lost ground in the past 25 years. The sub-par performance of all the tech companies in the original Nifty Fifty, including IBM , shows the difficulty of maintaining dominance in a fast-moving industry.

In the years after the crash of the original Nifty Fifty, many observers figured those kinds of valuations never would be seen again. Forbes magazine wrote in 1977 that the Nifty Fifty era smacked of tulip bulbs and the "temporary insanity of institutional money managers." Forbes then concluded that hardly any company was worth 50 times earnings.

But were all of the Nifty Fifty overvalued? To help answer that question, Siegel makes an interesting calculation: He determines a "warranted P/E" for each stock in the Nifty Fifty, using whatever stock price back then would have resulted in gains that equaled the return on the S&P over the past 25 years. Philip Morris , the top-performing stock since 1972, should have had a P/E of 78 in 1972, rather than its actual multiple back then of 24, Siegel argues. Coke deserved a P/E of 92, double its 1972 P/E of 46. Polaroid, by contrast, should have had a P/E of just 16.5, not 95. But that's hindsight. Today it's easy to forget the wild enthusiasm that was generated by instant photography in the 'Sixties and early 'Seventies. Millions of Americans owned instant cameras, and Polaroid's chief, Edwin Land, was a pop hero like some of the Silicon Valley barons of today.

Today's Nifty Fifty don't look as pricey relative to the S&P as their forebears did in 1972, but that's partly because today's Nifty Fifty have essentially taken over the S&P. The top seven companies in Morgan Stanley's Nifty Fifty are the same as the seven largest stocks in the S&P 500. In the transition, industrial companies and other economically sensitive stocks have largely been banished from the upper reaches of the S&P, and that has increased the index's P/E.

Also, the original Nifty Fifty were a gamier lot than the current bunch. To match the highflying nature of the 1972 Nifty Fifty, today's roster probably would have to include outfits like America Online , Dell Computer , Cendant , Lucent Technologies and maybe even Yahoo! .

Tom McManus, an independent market strategist who conceived the new Nifty Fifty while working at Morgan Stanley, argues the current stock market is a lot like a Mercedes-Benz: "It's expensive, but you get what you pay for." He says the S&P 500 may have a higher P/E than at any time in the past, but he adds, "You're getting greater quality than you did a generation ago."

He says investors are rightly paying a premium for the top companies in the S&P because of their strong franchises. McManus concedes that few of the leaders boast sizzling profit growth, but investors rightly prize the sustainability and consistency of their earnings.

The comparison between the Nifty Fifty's rates of earnings growth and their price-to-earnings ratios is captured in the nearby table. Anything above 1 in this column means the P/E of the stock exceeds its long-term earnings growth rate, meaning the stock looks pricey by this measure.

Even Siegel, whose book makes the case that stocks are by far the best long-run investment, admits he's a "little scared" about the current market. Clearly, last week's market action indicates that investors are a little scared, too. They apparently want more reassurance about earnings and economic growth before they push the Dow past 9000.

One last word of caution: Although you would have nearly matched the S&P by buying the Nifty Fifty in 1972, remember, you would have done a heck of a lot better buying them in 1980.

VALUE INVESTING IN INDIA

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