Will You Be Satisfied With 7% Returns?

7.2%.

That's what Jeremy Grantham recently predicted stocks will return -- after inflation -- on an annualized basis over the next seven years.

Is that good enough for you?

Who on earth is Jeremy Grantham?
Jeremy Grantham is the co-founder of investment firm GMO, which currently has approximately $90 billion in assets under management.

Grantham is often dismissed as a "perma-bear" when his views go against Wall Street's institutionalized optimism -- but the truth is, he's a rock-solid investment thinker, grounded in reality, who calls 'em like he sees 'em.

He believes that "mean reversion is the most powerful force in financial markets." In other words, periods of abnormally high returns must be balanced out by periods of abnormally low returns, and this holds true across the gamut of different assets, whether it be commodities, stocks, or bonds.

On that basis, at the end of 2001, Grantham predicted that the S&P 500 would suffer an annualized decline of 1.1% over the following seven years -- which was decidedly optimistic, since the annualized real return turned out to be negative 3.9%.

In July 2007, as the credit crisis was in its infancy, Grantham wrote: "In five years, ... at least one major bank (broadly defined) will have failed." We've all witnessed the multiple failures, rushed takeovers, and government rescues in the financial sector since then.

So, it's worth taking his predictions seriously.

7%? Seriously?
It may be hard to imagine 7% annual returns (after inflation, no less!) right now, what with the S&P 500 down approximately 50% from its all-time high in October 2007, but that decline has, in fact, set the stage for investors to earn 7% -- near the average historical return on stocks -- going forward.

The drop has been a source of enormous pain for investors -- but from the point of view of the prospective stock buyer, it's a great opportunity since stocks are at lower valuations than they have been in years.

In fact, Grantham called U.S. blue chips "manna from heaven"; indeed, when the credit crisis began to escalate, he said "they were about as cheap, on a relative basis, as they ever get."

I wanted to verify that claim, and I was able to confirm that over one in four non-financial stocks in the S&P 500 are cheaper in terms of their price-to-book value multiple than they have been in over 14 years. They include these superb companies:

 

Price/Book Value

Forward Price/Earnings

Oracle (NYSE: ORCL  )

3.3

10.4

Cisco Systems (Nasdaq: CSCO  )

2.5

14.5

Procter & Gamble (NYSE: PG  )

2.3

12.7

eBay (Nasdaq: EBAY  )

1.3

8.4

CVS Caremark (NYSE: CVS  )

1.1

12.3

General Electric (NYSE: GE  )

1.0

8.1

Alcoa (NYSE: AA  )

0.4

N/A

Source: Capital IQ, a division of Standard & Poor's, as of March 16, 2009.

But what if you aren't satisfied with 7% returns?

Getting to 7% *plus*
Grantham's prediction is based on the S&P 500, in aggregate, being fairly valued (he's currently pegging its fair value at 950). And if you pay fair value for the index, you can expect to earn the weighted average return that the underlying companies earn on their equity.

But within the S&P 500, some stocks will likely be overvalued, and some will likely be undervalued. If you're able to buy an individual stock for less than its fair value, that margin of safety will turbo-charge your expected return beyond the company's accounting return on shareholders' equity.

Grantham expects a subset of U.S. stocks -- those he labels "high quality" -- to produce after-inflation annualized returns of 11.2% over the next seven years. Four percentage points on an annualized basis is an enormous difference -- and gives investors plenty of incentive to identify those "high quality" stocks.

Although Grantham doesn't directly define "high quality," he provides some clues in an interview with Forbes in which he said, "And the best bet, for my money, then and now, a year later, was to buy the great franchise companies, the great quality companies." This suggests that he favors companies that possess a moat -- a sustainable competitive advantage -- and that earn excess returns over their cost of capital.

Helping you earn better returns
No investor is "condemned" to 7% returns going forward -- and neither are we promised them. Investing -- at reasonable prices -- in excellent businesses that are likely to grow is the best strategy for securing your long-term returns.

Of course, even among stocks that are perceived as "high quality," you can expect a range of different returns. The trick is identifying which stocks are genuinely undervalued.

That's what we do at Motley Fool Inside Value. If you'd like to find out which stocks will afford investors the best odds of earning premium returns to beat Grantham's 7.2% benchmark, just click here to sign up for a 30-day free trial today. You'll be able to see all stock recommendations, including Inside Value's five best ideas for new money now.

Alex Dumortier, CFA has no beneficial interest in any of the companies mentioned in this article. Procter & Gamble is a Motley Fool Income Investor pick. eBay is an Inside Value and a Stock Advisor recommendation. The Fool owns shares of Procter & Gamble. The Motley Fool has a disclosure policy.


Read/Post Comments (41) | Recommend This Article (57)

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 March 18, 2009, at 2:31 PM, Brettze wrote:

    Either you pick.... high stock returns or high income taxes... this is a no brainer..

  • Report this Comment On March 18, 2009, at 2:31 PM, Brettze wrote:

    Nature as well as taxes ahbor vaccum like those of you airheads or vaccuum heads!!

  • Report this Comment On March 18, 2009, at 2:33 PM, Brettze wrote:

    None of you can just ignore the needs of our society that can be met by high taxes or high stock returns... any better idea?? sure there is better ideas but they are in uncharted terrorities..

  • Report this Comment On March 18, 2009, at 2:34 PM, Brettze wrote:

    you can not just park trillions in money market funds and expect low taxes and low stock returns.. You simply cannot.. If you can, then you will earn negative returns on your money market funds... like minus 2% or minus 5%, how does it sound to you..

  • Report this Comment On March 18, 2009, at 2:37 PM, Brettze wrote:

    Or high inflation, oh yeah!!

  • Report this Comment On March 18, 2009, at 2:37 PM, mpwh wrote:

    Nah, my money is never coming back to the United States. If I keep it on a Brazilian savings account I can earn 7 to 8% yearly, and they are tax free. And I am talking about a savings account, something that is totally insured by Brazilian government. There are many other investments overseas and they are all better than anything in the US. Chinese stocks, Brazilian stocks, anything outside the US and Europe.

  • Report this Comment On March 18, 2009, at 2:38 PM, Brettze wrote:

    they are starting to rear up their ugly heads at stores.. I have seen them all recently... nobody is smarter than anybody... only faster..or slower or plain stubborn

  • Report this Comment On March 18, 2009, at 2:39 PM, Brettze wrote:

    the company you work at may not be able to borrow because you put your savings in Brazil, stupid!

  • Report this Comment On March 18, 2009, at 2:40 PM, mpwh wrote:

    And at this time, Brazilian and Chinese governments and institutions are way more stable than our battered US government...

  • Report this Comment On March 18, 2009, at 2:40 PM, Brettze wrote:

    i am all for free trade and such.. but total abandonment of America, oh stupid you!

  • Report this Comment On March 18, 2009, at 2:41 PM, Brettze wrote:

    We are nearing total abandonment of our whole automotive industry.. When it goes, ooh you will see what is comin', stupid!

  • Report this Comment On March 18, 2009, at 2:41 PM, mpwh wrote:

    I don't work! I make money. So, screw those who work... Money got no flag, no nation. Money is good and warm in my pocket...

  • Report this Comment On March 18, 2009, at 2:44 PM, mpwh wrote:

    Capitalism got no nation. Money is the power behind progress. The flags have no value when your pocket is empty. So, Capitalism first.

  • Report this Comment On March 18, 2009, at 2:49 PM, Brettze wrote:

    even in search of financial safety, many of you still will end up devoured by unseen, unknown forces from outside.. It is futile to think that you can find safety.They always find ways to catch up with your flight for safety.. They will usually get you before you knew it.

  • Report this Comment On March 18, 2009, at 2:50 PM, mpwh wrote:

    Well, I gave lots of myself to the USA. I been in two of our government wars. I always paid my taxes. Until the day I learned that this flag and nation thing benefits only the politician thieves in DC. So, I cashed all my money, and moved to a Tax paradise in the Caribbean. I don't care about a bunch of Illegal Immigrants living from welfare's money in some of the many crime-ridden ghettos of the USA. I care about my pocket, if it is full, I am happy. The Mexican-Americans or the Cuban-Americans can take care of themselves...

  • Report this Comment On March 18, 2009, at 2:52 PM, Brettze wrote:

    Capitalism is a term that cannot exist wholly on its own.. Capitalism need to depend on other forces for its existence or it will burn up so rapidly. It is like flooring your gas pedal with the neutral gear on.. The engine will blow out! You need a transmission to keep load on the engine in order to do the work.. That is why we have regulations and such.. You can not be so Jeffersonish about it.. That is bull!

  • Report this Comment On March 18, 2009, at 2:56 PM, Brettze wrote:

    The rich keeps on getting richer much similiar to the engine revolving faster and faster.. If it keeps on like that, our economy will definitely blow up! I just know that. The rich has too much idle money that they dont know what to do with . It seems that our government is better at spending money than the rich do.. I dont care if you call it a waste here or there.. We are functioning fine. Other nations are not as fortunate even with stable governments. People over there are hurting like heck but the rich .. It seems that it is kind of immature to be rich and not knowing what to do with your friggin' money other than parking them in money market funds that keeps on swelling at now what? $8 trillion or so. That is nuts!

  • Report this Comment On March 18, 2009, at 3:03 PM, Brettze wrote:

    The rich keep on getting richer by running away from America and our govenment is left with the unsavory and unpalatable politics of trying to raise revenues through higher taxes that need not happen had the rich spend money themselves .. The rich already had yachts, jets, islands, you name it. and they are filled up and have nothng else to do or say other than keep working against our government as it is hard at work trying to provide for our people as Americans.. I guess you want to proivide for Braziliains that their government is too corrupt to provide themselves.. You see, that is more than just simple capitalism.. "What is in your wallet?" is what matters the most.. Once you thought you are having it so good so why not hop over to Brazili or China, it will catch up to you like a real mean dog biting your rear end!! ... before you knew it... Think karma if you dont like karma.. let me think of soemthing else.. That is what is so hard about politics... Most of us dont bother to observe the complexities of politics and are too perfectly blissful to ignore them.. They will bite you !! You cant ignore them.

  • Report this Comment On March 18, 2009, at 3:07 PM, Brettze wrote:

    I am not saying that you cannot go overseas to do business or buying stuff made overseas.. all i am saying is use your financial judgements. You cant just keep on taking every advantage every time it comes up without regards of the consquences.. There is times to stop and think and there ,of course, is times to think for yourselves. You are not going to get away with it all the times either way. Free trade is healthy and no government can referee free trade.. Only you on your part can and each of you using everyday decisions that will perish the next day and changes will be expected . There is not always only two choices to make but there can be five choices to make or more sometimes.. Keep your mind open and do what you can do to keep America strong even with all its warts..

  • Report this Comment On March 18, 2009, at 3:13 PM, Brettze wrote:

    Let me give you an example... Americans were SUV crazy becausse they thought they can have them without worrying about the consquences like energy crisises. What they actually did was creating more problems while they are in mindless pursuits of happiness. We had been knocked on the forehead on the energy issues for several decades , yet we continue to remain blissful and ignorant.. Now, GM and Ford suddenly found themselves unable to hock SUVs even to the dictators of the world at all. Nobody wants SUVs and GM and Ford just cannot retool plants overnight.. UAW got its nose bloodied. There is similar ongoing examples still ongoing all over America and overseas.. I know, it is complicated for any ordinary American to stop and think about what the right decision should be made on a daily basis. Our media is not doing a great job of communicating about directions that America should take. Is America in decline? If so,, are you sure you still want to put your savings in Brazil? You are free to do that, sure thing... this is your decision for right or wrong! Remember consquences do bite!! Really hard!!

  • Report this Comment On March 18, 2009, at 3:19 PM, Brettze wrote:

    I am not saying that every American got to make a right decision every time or America will go bust.. It is okay to spoil whenever you cant figure out how to make a right decision so therefore you let ignorance dominate. This will not hurt.. But if more and more of you start to make intentional misdecisions just out of sheer disrgard and in pursuit of your peverse happiness.. Then this is a total and wholly different story. That is why some people do hedge their decisions with decisions. Nobody knows for sure if it is a right thing to do or not every time.. It is a constant guesswork based on inputs of daily information bombarding at you all around you. It is useufl to stop and sit down and think and look around you and keep your blind loyalty in check.. Keep your minds open .

  • Report this Comment On March 18, 2009, at 3:21 PM, Brettze wrote:

    I support capitalism because it is instrumental to our economic progression, but it is very unwise to think that it is all we need.. That is pure fantasy.. It is actual dog eat dog world as far as capitalism goes.. Someone has no choice but to pull dogs apart often enough. This is not going to happen.. and it better not. This is nothing short of insanity!

  • Report this Comment On March 18, 2009, at 3:28 PM, Brettze wrote:

    Everyone has his own hang ups . It is natural for someone to be called meddlesome when he tries to rein you a bit. Nobody wants to run your lives. It is good to have liberty and freedom as long as you dont become a major nusiance to others. It is no different than telling your capitalist kid to clean up his bedroom . We cannot just leave messes around and ignore them because our places are still clean .. I mean financial messes as well as physical messes, too.

  • Report this Comment On March 18, 2009, at 3:29 PM, Brettze wrote:

    End of sermon!

  • Report this Comment On March 18, 2009, at 4:39 PM, kpmom wrote:

    Brettze, write more next time, 'k?

  • Report this Comment On March 18, 2009, at 4:53 PM, SpiritWolfIII wrote:

    AND use semi-proper English while you are at it.

  • Report this Comment On March 18, 2009, at 5:31 PM, thedofca100 wrote:

    Yes, I'd be thrilled with 7% after inflation. In fact, I'm going to settle for 5% before inflation but I'll have insured investments. If people don't mind how they are being scammed all the time by investment firms, banks, and wall street then they can go for it. I like my money more than that. Will I lose some to inflation? Sure. Will I lose 50% to a down market? Nope.

  • Report this Comment On March 18, 2009, at 6:57 PM, OctoStalin wrote:

    thedofca100

    Have you considered getting your money out of the US dollar by any chance? You don't necessarily need to suffer inflation.

  • Report this Comment On March 18, 2009, at 7:34 PM, xetn wrote:

    What would greatly help the stock market and all markets would be a return to a real gold standard. This would virtually eliminate inflation since it would prevent the Fed (a useless fraud) from inflating the currency. Most of the rise in stocks and houses are due to an inflated currency. A stable money would return true appreciation in stocks and would also greatly reduce the effects of boom-bust cycles. But we also need to eliminate the Fed, the IRS and its taxes, fractional-reserve banking and most government regulation. We also need to close all foreign military bases and return our people to the US. That would reduce the budget by billions or trillions.

    There is so much more that needs to be done as well. But I suspect that most of you want government taking care of all of your needs because government knows better than you how to manage your life and money.

  • Report this Comment On March 18, 2009, at 9:01 PM, trenton1ryan wrote:

    <which currently has approximately $90 billion in assets under management.>

    Why do we always need to know this?? Those assets got destroyed in this recent downturn-just like the vast majority's. $90 billion, ooooh, I'm impressed. So what. How did the $ under mgmt do between May '08 and Feb '09??

    "If you can't dazzle them with brilliance, baffle them with bull--it."

    ps-Brett: STFU.

  • Report this Comment On March 18, 2009, at 9:52 PM, sickofliberals wrote:

    It's not the governments job to provide for the American people. It is your job to provide for yourself! You have the right to spend your money the way you see fit. The rich pay the majority of taxes already in our country. Tax breaks for people who pay little or no taxes is welfare.

  • Report this Comment On March 19, 2009, at 9:39 AM, ReillyDiefenbach wrote:

    Well, you may be sick of liberals, but the American people have spoken loud and clear. Your worn out trickle down voodoo economics and your unending war on the middle class haven't worked out real well, so you've been fired, see. We're going a different way. We're going to tax you more, because you deserve to pay your fair share. You're out in the wilderness, one hopes for the next forty or fifty years at least..

  • Report this Comment On March 19, 2009, at 1:29 PM, paducah5102 wrote:

    I have never read more inane jibberish in one place than in responses to this post. Does this represent the collective wisdom of MF subscribers?

  • Report this Comment On March 19, 2009, at 6:52 PM, 7t52day wrote:

    Way to go "xten".

    And let's really get basic. Starting with real activism by each one of us, WE are government...let's find out what's going on, instead of letting our representatives be influenced by PAC's and lobbyists.

    We have good systems...they're being administered improperly.

    Stop the graft, the "pork"and political plums.

    When an individual or firm breaks the rules and does not handle our money in the manner we expected when we entrusted them with it, let the make restitution and serve the time. Take away the bonuses and parachute clauses when businesses, funds and other money-management people are neglectful of the the positions they're in. Business IS business...Run it correctly, or suffer the consequences.

    And, for pete's sake, stop these bailouts to companies scream for help, and continue doing the saqme outlandish things that fly in the face of each honest, hard-working American.

  • Report this Comment On March 19, 2009, at 10:09 PM, AustinAndy wrote:

    As long as Mr Immelt is in charge of GE, I would not touch it with a ten foot pole. He has done absolutely nothing for the stock during his ten year tenure.

    AustinAndy

  • Report this Comment On March 20, 2009, at 4:38 PM, WillduRANT4 wrote:

    RE: On March 19, 2009, at 9:39 AM, ReillyDiefenbach wrote: Well, you may be sick of liberals, but the American people have spoken loud and clear. Your worn out trickle down voodoo economics and your unending war on the middle class haven't worked out real well, so you've been fired, see. We're going a different way. We're going to tax you more, because you deserve to pay your fair share. You're out in the wilderness, one hopes for the next forty or fifty years at least..

    Forty or so MONTHS at most. America won't tolerate that wooden-headed puppet who currently occupies the Oval Office for long.

  • Report this Comment On March 20, 2009, at 4:51 PM, gringo0900 wrote:

    Its time to bailout, I'm moving to Mexico. Even with 40% losses on real estate and investments I can lead a rich life there. I'm not breaking my back anymore in the US rat race to pay dramatically higher taxes than I pay now.

    Adios Amigos!

  • Report this Comment On March 23, 2009, at 12:09 AM, TrailerParkJawa wrote:

    I think it is a bit silly to ask if I would be happy with 7% returns after looking at the performance of my stocks over the 12 years I've been investing. Frankly, I would have been better off with a savings account at my credit union all this time.

    What scares me the most now isn't getting 5% or 7% over the next 10 years but having to go through another crash of the market sometime in the next 10 years.

  • Report this Comment On March 24, 2009, at 2:52 PM, TradePro1982 wrote:

    I came across this superb article on how to condemn the AIG fatcats, it actually made me feel quite good. One of the best articles I have read, well worth the copy and paste.

    http://www.bukisa.com/articles/48974_how-to-condemn-the-aig-...

    This made me laugh out loud, forward to anyone affected by AIG.

  • Report this Comment On March 24, 2009, at 6:09 PM, whcernan wrote:

    The only thing that Bukisa article made me feel good about was this:

    At least I can write a sentence or two that are mostly grammatically correct.

  • Report this Comment On March 26, 2009, at 6:25 PM, chemdude47 wrote:

    7% real returns? Not bad at all. Many people will do much worse.

    Pull all your money out of America? Well, if you believe that is the thing to do...Just one more thought about this: is it not in human nature to tend to believe the grass is greener elsewhere?

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 854465, ~/Articles/ArticleHandler.aspx, 8/21/2014 8:03:04 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement