Tensions in the Ukraine pushed stocks lower. Solid earnings sent
markets higher. Manufacturing data weighed on equities.
On a day-to-day basis, you'll hear all sorts of explanations for
why stocks move one way or another. But what about over the longer
term? What factors really drive equity prices over the long haul?
And, perhaps most importantly, can we quantify them?
A 2010 study from MSCI Barra, entitled "What Drives Long-Term
Equity Returns?", attempted to do just that -- and its findings
likely aren't what you'd expect.
Barra (whose market indices are widely used by investors around
the world) studied equity returns from 1975-2009 in a variety of
markets, and broke down those returns into several components. The
major ones: inflation; real book value growth (i.e., how much the
company's underlying business and assets grow); price-to-book
growth (how the amount of money investors are willing to pay for
every dollar of that book value changes over time); and dividend
The results: According to Barra, the most significant of those
components is inflation, which accounted for 4.2 percentage points
of the MSCI World Index's 11.1% return from the start of 1975
through Sept. 30, 2009. The second biggest factor: dividend income,
which accounted for 2.9 percentage points. Real book value growth
and price-to-book growth accounted for 2.1 and 1.5 percentage
points, respectively. The results were similar for many of the
markets within that world index, including the U.S.
What that indicates is that over the long run, about two-thirds
of the stock market's returns are the result of inflation and
dividend payments -- two un-sexy factors to which many stock
investors don't give enough thought.
When it comes to inflation, the work of contrarian guru David
Dreman supports just what an impact it can have. Dreman, whose
writings are the basis for one of my Guru Strategy computer models,
has called inflation a "virus" that permanently entered the
investment world after the Second World War. He found that over the
long term, inflation eats away tremendously at the return of
fixed-income investments like bonds or Treasury bills. Stocks,
however, can draw on increasing earnings streams as companies raise
prices and increase profits to keep up with inflation. Inflation is
thus, to some extent, built into the companies' bottom lines, and,
in turn, into stock prices as well.
As for dividend income, the implications are clear: While most
investors today focus on stock price appreciation, good ol'
dividend yield shouldn't be ignored in any market environment.
Currently, long-dormant inflation has begun to pick up a bit.
And, strong yields are tough to come by, both because of the
downward trend we've seen in dividends over the past couple decades
and because the ultra-low-interest-rate environment has led many
yield-hungry investors to bid up the price of high-dividend picks
-- currently only about 115 stocks in the market get approval from
my Guru Strategies and yield 3% or more. With that in mind, here
are a few of the high-yielders that do get approval from my models,
and which should have the pricing power to capture inflation-driven
Energy companies are a good inflation hedge, and my James
O'Shaughnessy-based model sees value in this California-based oil
and gas giant ($254 billion market cap), which is also involved in
the lubricant, petrochemical products, geothermal energy, and
biofuels markets. When looking for value plays, O'Shaughnessy
targeted large firms with strong cash flows and high dividend
yields. Chevron is plenty big enough, and it has an impressive
$18.25 per share in cash flow (more than 10 times the market mean).
It also sports a solid 3.2% yield, all of which help it pass the
The Coca-Cola Company (
The Atlanta-based beverage giant ($179 billion market cap) is a
longtime holding of Warren Buffett's, in large part because of its
"durable competitive advantage". That advantage is due to its huge
brand recognition and size, which give it the sort of pricing power
that allows it to raise prices if inflation hits.
While Buffett has long liked Coke, it's my O'Shaughnessy model
that is high on its shares right now. The strategy likes Coke's
size, $2.36 in cash flow per share, and 3% dividend.
Kellogg Co. (
Some have speculated that Buffett's Berkshire Hathaway might be
interested in buying this Michigan-based food giant, whose
well-known brands and products include Rice Krispies, Eggo, and
Pringles. My Buffett-inspired model thinks Berkshire would be wise
to give Kellogg (3% dividend) a long look. The firm ($23-billion
market cap) has upped earnings per share in all but one year of the
past decade; has averaged a stellar 43.2% return on equity over the
past 10 years; and has enough annual earnings that it could pay off
its long term debt in less than three years if need be, all of
which are very "Buffett-esque" qualities. And, because it sells
consumer staples with big brand names, it should have good pricing
This Netherlands-based maker of home goods and food products counts
Lipton, Hellmann's, Dove, Slim-Fast, and Vaseline among its big
brand names. The O'Shaughnessy-inspired model thinks it's a good
value play. The strategy likes Unilever's size ($130 billion market
cap), $3.21 in cash flow per share, and solid 3.3% dividend
BASF SE (
This Germany-based chemical company offers a variety of products
for a variety of industries. Its portfolio ranges from chemicals,
plastics, and performance products to crop protection products to
oil and gas industry products.
BASF gets high marks from my Peter Lynch-based model. Its 16.4%
long-term earnings-per-share growth rate (using an average of the
three-, four-, and five-year rates) and high sales (nearly $100
billion in the past year) make it a steady "stalwart" according to
this model. Lynch famously used the P/E-to-growth ratio to find
bargain-priced growth stocks, adjusting the "growth" portion of the
equation to include dividend yield for stalwarts. When we divide
BASF's 14.8 price/earnings ratio by the sum of its long-term growth
rate and dividend (3.5%), we get a PEG of 0.75. Anything under 1.0
is considered a good value to this model.
I'm long K, CVX, and BASFY.