Investors have two important anniversaries to commemorate this month. One is the seven-year anniversary of the current bull market. The other is the 16-year anniversary of the Internet bubble.
Both impart vital knowledge every serious investor must absorb. And both underscore the most important lesson in all of investing.
The question is, “Have you truly learned it?” Let’s start with the current bull market…[ad#Google Adsense 336×280-IA]Since bottoming on March 9, 2009, the U.S. market has put on a historic rally.
Large cap stocks have more than doubled.
Small cap stocks have more than tripled.
With dividends reinvested, the returns are stronger still.
According to Wilshire Associates, the bull market has put more than $16 trillion into the pockets of equity investors.
(Of course, a good bit of this wealth was taken out of those same pockets in the preceding bear market.)
The gains have not been evenly spread, however. (They never are.)
A substantial part of the jump in the large cap indexes is due to a handful of outstanding performers. Since the market low of seven years ago, Microsoft (Nasdaq: MSFT) is up 249%, Wells Fargo (NYSE: WFC) is up 390%, Alphabet (Nasdaq: GOOG) – formerly known as Google – is up 399%, Apple (Nasdaq: AAPL) is up 751% and Amazon (Nasdaq: AMZN) is up 825%.
Many equity investors have done well over this period, especially those who stepped up to buy when things looked particularly bleak.
This was no anomaly. History shows that when low valuations are combined with abject pessimism, future returns are much higher than average.
History also demonstrates that when sky-high valuations are combined with giddy optimism, future returns are much lower than average.
That brings us to the Internet bubble.
Sixteen years ago, the market’s best-performing stocks were technology shares. Investors were convinced that “the Internet changes everything.”
And they were right in many ways. The Internet has changed the way most of us live, work, play, bank, travel and entertain ourselves.
But it didn’t change the iron law of successful stock market investing: Valuations matter.
Sixteen years ago, large cap technology shares like Cisco’s (Nasdaq: CSCO) sold for more than 200 times trailing earnings. And most of the Internet darlings didn’t have earnings (or often sales) at all. Without earnings, of course, there is no P/E ratio to calculate.
So investors focused instead on things like potential market share, web hits, “eyeballs” and other metrics too fatuous to mention. It all ended badly, of course.
The leading index of Internet shares declined more than 95% over the next three years. And even the technology-laden Nasdaq is roughly 10% below the highs of 16 years ago.
Sixteen years is a long time to hold a stock index and not break even. But even an investment in the more broadly diversified S&P 500 was slightly negative 10 years after the market peak in March 2000.
Why the rare down decade? Because at its high in March 2000, the S&P 500 sold at a nosebleed 28 times earnings. Today it is a more modest 19 times earnings, still higher than the historic average of 16 but hardly bubble territory, especially in an era of ultra-low inflation, ultra-low interest rates and ultra-low energy prices.
So what should we learn from the table-pounding sell of 16 years ago and the incredible buy of seven years ago?
That when you buy sound companies that are selling for far less than they are worth, you get well rewarded. And when you pay far more than companies are worth, you get severely punished.
How do you measure a company’s true worth? By the relationship between price and earnings, book value, growth prospects, and dividend yield.
It’s called value investing. And it remains the greatest investment technique of all, providing the best long-term returns with the highest margin of safety.
And that’s what intelligent money management is all about.
Source: Investment U