Will This Decade Tank Your Portfolio?

The past decade has many investors ready to give up on stocks almost entirely. Stoked by the misguided talk of some pundits, they look at the equity market's red ink over the past 10 years and think that investing has drastically changed. In some cases they're even convinced that the next decade will look a lot like the last.

There is so much wrong with this that I almost don't even know where to begin.

The smoking gun
The claim that returns have been abysmal over the past 10 years is hardly exaggerated. Between the start of 2000 and the beginning of this year, the S&P 500 index dropped 23%. Many individual stocks fared even worse.

Company

Stock Return

Corning (NYSE: GLW  ) (55.1%)
Cisco Systems (Nasdaq: CSCO  ) (55.3%)
Merck (NYSE: MRK  ) (45.6%)
Comcast (47.2%)
Home Depot (NYSE: HD  ) (57.9%)

Source: Capital IQ, a division of Standard & Poor's. Stock returns are Jan. 1, 2000, to Jan. 1, 2010.

Obviously, something went very wrong over the last decade because above we've got a group of high-quality companies from a variety of industries and each and every one would have put a major dent in your portfolio.

Here's what happened
Now you can focus on the awful returns shown above -- as some pundits are -- or you can look a bit closer to find much more interesting data. Same companies, much different picture.

Company

Earnings-Per-Share Growth

2000 Trailing Price-to-Earnings Ratio

2010 Trailing Price-to-Earnings Ratio

Corning 97.2% 66.2 15.1
Cisco 207.7% 158.5 23
Merck 130.6% 27.4 6.5
Comcast 99.4% 50.5 13.4
Home Depot 55.3% 68.9 18.7

Source: Capital IQ.

To look at the earnings growth for these companies, it sure doesn't look like it was a lost decade. So what happened? Investors were paying way too much 10 years ago.

Has good investing changed a lick? No! Paying astronomical prices for even good companies is, has been, and always will be a bad idea.

The terrible decade ahead
So what happens if we really do end up with another decade like the one we just endured? In the first scenario below, earnings growth is in line with analysts' expectations over the next five years, and then 3% for the following five. In the second scenario, growth is simply 3% for the entire 10 years. In both, the stock prices fall just as they did over the past decade.

Company

Scenario 1: 2020 Trailing Price-to-Earnings Ratio

Scenario 2: 2020 Trailing Price-to-Earnings Ratio

Corning 3.1 5.1
Cisco 4.8 7.7
Merck 1.6 2.6
Comcast 3.3 5.3
Home Depot 3.6 5.9

Source: Capital IQ.

Could it happen? Sure. Rationality isn't always the stock market's strong suit. And while the first scenario is a pretty big stretch, some investors are actively betting that we will see something like the second scenario because valuations have fallen to similar levels in the past.

And to be sure, it's a tempting thought -- I'd love to be buying stocks at valuations like those. But if the hoped-for decline doesn't come, or it doesn't hit some magic "buy now" level, then investors waiting around for these rock-bottom prices will be left out in the cold.

Buy now, buy more later
I think it's much more likely that the stocks above will never even sniff those bargain-basement valuations and that the much-feared "U.S. Lost Decade for Equities: Part II" won't materialize.

However, there's a simple solution for getting the best of both worlds -- it's not assuming that you have to do all of your buying at one time. There's nothing to say that you can't do some buying today -- to benefit from companies' earnings growth in years ahead -- and keep some money on the side in case better buying opportunities arise. Better still, if you're truly Foolish then you're adding to your portfolio every month with new savings, so you've constantly got new money that can be put to work on the best opportunities.

And what do the current best opportunities look like? They look a lot like this.

Company

Trailing Price-to-Earnings Ratio

Dividend Yield

Return on Equity

ExxonMobil (NYSE: XOM  ) 12.8 2.7% 15.3%
Johnson & Johnson (NYSE: JNJ  ) 13.1 3.4% 16.4%
Altria (NYSE: MO  ) 14.0 6.1% 24.5%

Source: Capital IQ.

These are all established, solid businesses -- Exxon is the global energy powerhouse, J&J is a diversified leader in the pharmaceutical industry, and Altria is the sinful company behind the dominant Marlboro cigarette brand -- whose mettle is proven through healthy returns on capital. The stocks all carry very reasonable valuations and get their earnings back to their shareholders through quarterly dividend payouts.

While these screening criteria may seem pretty obvious, if you go back and look at past data (I have), you won't see all that many companies that are as high caliber as Exxon, J&J, and Altria that fit the bill. But because Mr. Market is eschewing blue chips right now, we can find these kinds of deals.

Think I'm dead wrong and the next decade will clobber investors? Set me straight in the comments section below.

There's a lot to admire about famed super-investor Warren Buffett, but that doesn't mean we should own every stock he does. In fact, Anand Chokkavelu thinks you should avoid these three Buffett holdings.

Home Depot is a Motley Fool Inside Value recommendation. Johnson & Johnson is a Motley Fool Income Investor recommendation. The Fool has written calls (bull call spread) on Cisco Systems. Motley Fool Options has recommended a diagonal call position on Johnson & Johnson. The Fool owns shares of Altria Group, ExxonMobil, and Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Matt Koppenheffer owns shares of Johnson & Johnson, but does not own shares of any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy assures you no Wookiees were harmed in the making of this article.


Read/Post Comments (19) | Recommend This Article (47)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 27, 2010, at 10:13 AM, GW1000 wrote:

    Good article Matt! In my opinion the lost decade for stocks was caused by the previous explosive decade that occurred in the 90's. The DOW increased from about 2000 to over 10,000 during this period, which was too much of an increase. I was not fortunate enough to be an investor during this period, but there have been a couple of good buying opportunities in the last decade. These occurred in 2002 and during the spring of 2008. I think the next decade will be much better for patient investors that invest mostly in solid dividend paying companies such as the ones you mentioned.

  • Report this Comment On October 27, 2010, at 2:15 PM, CPACAPitalist wrote:

    Hard to believe that people were happily buying up Cisco in 2000 with a trailing P/E of 158.5! No wonder we had to come crashing back down to reality. Good article - just imagine if everyone was required to understand these basic concepts of purchasing investments based on reasonable valuations!

  • Report this Comment On October 27, 2010, at 4:43 PM, lazytype wrote:

    One thing is certain about stocks and that is the market will fluctuate :)

  • Report this Comment On October 27, 2010, at 5:19 PM, joewatts wrote:

    This article gives us the stock return on the the first set of companies and then compares it in the other three scenarios to completely different data.

    What's up with that? If the article compared apples to apples that would be nice, but it's not expected in stock selling stories.

  • Report this Comment On October 27, 2010, at 6:18 PM, richie54 wrote:

    Very good article, Matt. Let's all remember something that's taught to all of us the first day of Finance 101. Over time, stocks tend to move upward. Time, however, can be a very subjective concept.

  • Report this Comment On October 27, 2010, at 8:00 PM, PositiveMojo wrote:

    Matt - I totally agree! I'm looking forward to what is going to happen over the next decade and we could see a big boost in the last quarter of 2010.

    In 2009 I made a 96.4% return by buying incredibly undervalued stock and then watched the stochastic and DMI indicators turn positive and started buying great, well managed companies. The same thing just happened this past month and I'm up about between 20-25% and still selectively buying. So, there is money to be made if you're paying attention. However, if you aren't very savvy you're likely to get your head taken off.

  • Report this Comment On October 27, 2010, at 8:29 PM, hbofbyu wrote:

    Nice illustration. It's interesting how many people do not consider valuation when buying stocks. It also shows that regardless of valuation and metrics, a stock's price will only move by supply and demand - who wants it and who doesn't. Unless it pays a dividend, owning a stock is nothing more than hope - a hope that more people will want it tommorrow more than they do today. (Which is why we could have another dangerous decade ahead)

  • Report this Comment On October 27, 2010, at 9:54 PM, HDB1 wrote:

    Now please apply your example to Index investing.

    what should one have done then, and what should one do now? It would also be helpful to take into account the US demographics of a declining baby boomer generation's purchasing power with far less replacements of purchasing power in the next 10 years or so.

    I'll await your response.

  • Report this Comment On October 27, 2010, at 10:27 PM, topsecret10 wrote:

    The lost decade coincides with our "lost" government. And by the way,our government Is still lost. As long as the FED and the Government work hand and hand to Inflate and Deflate our currency,while running up staggering amounts of debt,stocks cannot possibly sustain any type of LONG TERM rally. We will do the same thing we did In the last decade UNLESS we get a fundamental change of policies by our elected representatives,and open up the books of the FED so Intelligent economists can help to fix what has been wrong with a failed Fed policy for a generation. The BOOM- BUST cycle Is alive and well,and the next BUST Is looming In the very near future. We CANNOT keep printing money,spending money that we do not have,and completely fail to produce jobs like we are now. I rode the market from 5500 on the dow and CASHED OUT COMPLETELY when It hit 14,000. I did not get back In at all until MAY of 2009..... The market Is priced for perfection right now,but unfortunately,things are far from perfect,and we are In danger of a double -dip. I get really nervous when everyone Is happy as a clam,and everything Is just peaches and cream If you listen to all of the noise and chatter coming from the media. Sorry fools,but In my opinion the DOW has a better chance of hitting 9,000 before we get to 12,000. Very strong head winds,and November may be a month to remember.... TS

  • Report this Comment On October 27, 2010, at 11:02 PM, topsecret10 wrote:

    Think this economy is bad? Wait for 2012.

    By Greg Ip

    Sunday, October 24, 2010

    We're barely two years past the banking crisis, still weathering the mortgage crisis and nervously watching Europe struggle with its sovereign debt crisis. Yet every economic seer has a favorite prediction about what part of the economy the next crisis will come from: Municipal bonds? Hedge funds? Derivatives? The federal debt?

    I, for one, have no idea what will cause the next economic disaster. But I do have an idea of when it will begin: 2012.

    Yes, an election year. Economic crises have a habit of erupting just when politicians face the voters. The reason is simple: They are born of long-festering problems such as lax lending, excessive deficits or an overvalued currency, and these are precisely the sort of problems that politicians try to ignore, hide or even double down on during campaign season, hoping to delay the reckoning until after the polls close or a new government takes office. Perversely, this only worsens the underlying imbalances, making the mess worse and the cost to the economy -- in lost income and jobs -- much higher.

    http://www.washingtonpost.com/wp-dyn/content/article/2010/10...

  • Report this Comment On October 27, 2010, at 11:10 PM, topsecret10 wrote:

    Most leading economists expect the Federal Reserve to buy between $80 billion and $100 billion worth of assets per month under a new program to bolster the struggling economy, a Reuters poll found on Wednesday.

    Estimates for how long the Fed will print money and how much it will eventually spend varied widely, from $250 billion to as high as $2 trillion.

    In a similar Reuters poll of primary dealers conducted on October 8, dealers mostly forecast the total size of the new program at $500 billion to $1.5 trillion. Repeat after me, Boom - Bust-Boom- Bust !!

  • Report this Comment On October 27, 2010, at 11:24 PM, topsecret09 wrote:

    Forget a 2011 Dip, Try 2021 Economic ‘Armageddon’

    By: John Melloy

    Executive Producer, Fast Money

    U.S. government officials should make avoiding a trade war -- or worse -- with China a higher priority than trying to avert a short-term retrenchment in the economy next year, said hedge-fund legend Paul Tudor Jones in a provocative missive to investors this month.

    “Authorities on both sides of the Pacific now appear more concerned with avoiding a potential double-dip in 2011, than Armageddon in 2021,” wrote Jones, whose personal worth totals $3 billion, according to Forbes, after three decades navigating his hedge fund through the commodity, equity and currency markets.

    While Jones clearly plays down in the letter actual “combat” as a likely outcome, he is not the first investor to raise the specter of serious consequences to arise over the long term if the financial imbalances caused by the Renminbi-peg to the dollar are allowed to continue.

    China setting its currency artificially low worked well for both parties for a while. The U.S. got cheap goods and cheap labor and China got to transform from an agricultural based economy into an industrial one. With the money from selling to the U.S. population, China bought Treasuries, further funding an American credit boom that temporarily raised the quality of life here and turned many manufacturing jobs into higher-paying service positions.

    But with unemployment at double digits and China’s economy maturing into an industrial powerhouse with an emerging middle class that has domestic demand of its own, this once peaceful relationship is coming to a head.

    http://www.cnbc.com/id/39870414

  • Report this Comment On October 28, 2010, at 2:01 AM, tdiaczok wrote:

    Has anyone thought that the last 10 years for the US is like 1990-2000 in Japan ? Only 10 more years to go ...... so far.

    I'm surprised that any article purporting to present a future scenario for the stock market does not even consider the economy on which that stock market is based.

    I'd also like to respectfully suggest that the market only goes up while credit is going up.

  • Report this Comment On October 28, 2010, at 10:11 AM, bucheron wrote:

    Nice article!

  • Report this Comment On October 28, 2010, at 12:23 PM, exdividendday wrote:

    I would invest in Comcast (CMCSA). Warren Buffett is invested in this company with 0.42 percent of his portfolio. Comcast Corporation is a provider of video, high-speed Internet and phone services (cable services), offering a variety of entertainment, information and communications services to residential and commercial customers.

    CMCSA generated sales of USD 35.7 billion (+13.2 percent) in fiscal 2009 and a net income of USD 3.6 billion (+31.4 percent). Take care with the high debt of the company. Long-term debts of USD 27.9 billion were accounted. The cash flow amounted to USD 10 billion of which 5.6 billion in CAPEX were invested. CMCSA had properties, plants and equipments of USD 23.8 billion. Take a look at my sheet of 5 cable TV operator with some fundamentals:

    http://long-term-investments.blogspot.com/2010/09/5-cable-tv...

    The average dividend-yield amounts to 2.50 percent while the average P/E ratio is 17.52.

  • Report this Comment On October 28, 2010, at 5:04 PM, TMFKopp wrote:

    @truthisntstupid

    Great thoughts as always! Here's an answer to your question:

    http://www.fool.com/investing/general/2010/10/28/blue-chips-...

    Matt

  • Report this Comment On October 29, 2010, at 1:25 AM, PrincipleOf3rds wrote:

    Some day I'll share a plot that paints a crystal clear picture of our past, present, and future!

    The lost decade is not surprise to the wise fool.

  • Report this Comment On October 29, 2010, at 1:54 AM, PrincipleOf3rds wrote:

    One more note....

    Warren and many others have given you the basic rules...live by them!

    To refresh your memory here are a few wise investment axioms....

    1. Business and economies run in cycles.

    2. Find good companies with current and future potential.

    2. Buy into panics.

    3. Sell into hype.

    You would be surprised how many people I talk to that say..."I'm thinking about investing in stocks, I hear the market is going up." My response..."I have some stock you could buy."

    One personal example...I purchased nearly 300 shares of BP ($28.65 cost basis) this past summer. Once dividends kick back in...I'm looking at 10%-12% dividend returns annually on top of the already 40+% gains.

    One more example...while listening to the radio in 1/09, Howard Stern said that had faith in CEO of Sirius to pull off funding to save the company from bankruptcy. I placed a $1000K bet on Thursday at $.05/share, I knew I would have my investment answer by the following Tuesday. Now I'm sitting on 29 bager, which I plan on selling in February 2011 to minimize capital gains.

  • Report this Comment On October 29, 2010, at 2:08 AM, PrincipleOf3rds wrote:

    One last example....I was selling out of the market as housing began to turn, landing nice gains from 2003 to 2007. I was completely out as the DOW sunk below 12,000. As the slide lost gravity....I starting buying again, my last and largest purchases were about 1 months prior to the bottom....I've since sold out, except for the BP play this last summer and letting my Sirius bet ride....

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