Jeremy Siegel, Ph.D. The Future for Investors

Today things get interesting.

In my last column, "Old School Stocks Teach New Lessons," I showed that if you bought a portfolio of the original stocks chosen for the Standard & Poor's 500 Index in 1957 and never sold them, you would have outperformed the continually updated S&P 500 index that has become the benchmark for judging the performance of large U.S. stocks. In this column I will discuss the investment qualities of the winning stocks that powered this portfolio.

The table below lists the twenty best-performing of the original S&P 500 firms that have survived since the index was formed almost 50 years ago. If you were lucky enough to own a portfolio of these 20 stocks, you would have beaten the S&P 500 by more than 4.5% per year and seen your wealth grow eight times the level it would have grown to in the S&P 500. Even the number 20 stock on the list beat the index by 2½ percentage points and grew to a level three times higher than the market. The top performer grew to an astounding accumulation of 50 times the market.

The 20 Best Performing Stocks

What strikes one immediately about these winning stocks is the dominance of two industries: consumer brand-name companies and large pharmaceuticals.

There is no doubt that all these firms on the list grew quickly over the past half century. The earnings per share growth of these top 20 stocks averaged 9.7% annually, nearly four percentage points above that of the S&P 500. But the critical element to the superb returns is not just the earnings growth, but the price at which investors were able to buy this growth. The average price ratio of these fast-growing firms over the past half century was only 19.17x, just a bit above the market

It cannot be emphasized enough that the key words in this strategy are "At a Reasonable Price." Many stock investors go for growth alone, without paying attention to the price they pay. As this column has repeatedly warned, this is like always betting on the favorite no matter what the odds. If the favorite comes in one of three times, you are not going to be happy if you only win back twice the bet you made on it. Yet that is what often happens when investors pay premium prices for "growth" stocks.

Why Dividends Are Crucial

But there is another important characteristic of these winning stocks. Over the past five decades, each has paid a dividend (only Kroger does not today), and the dividend yield of these stocks has been, on average, higher than the dividend yield on the S&P 500. This fact should put to rest arguments that those firms that pay high dividends do not have growth opportunities and therefore should be shunned by investors.

Recently, some of the stocks on this list have fallen on hard times. The woes of the pharmaceutical firms, such as Bristol-Myers, Pfizer, Merck, and Abbott Labs, are well known. A combination of litigation, patent expirations, and a lack of promising drugs in the pipeline has pushed the prices of these stocks downward.

Furthermore, Coca-Cola, for many decades one of the greatest growth stocks and a favorite of Warren Buffett, has been unable to keep up with PepsiCo and other firms that sell non-alcoholic beverages. Nevertheless, over the long run all of these stocks have greatly rewarded their investors.

Interestingly, virtually all of these stocks, despite their history of remarkable returns, have reasonable P-E ratios today. The average forward looking P-E ratio of these twenty stocks is currently 16.33x, which is only one point higher than the S&P 500.

I am not saying that all these firms on this list will outperform the S&P 500 in the future. But in today's market, investors will be rewarded by buying firms that have steady earnings and a world-wide franchise, pay a dividend, and sell for a reasonable price.