I had recently chanced upon an old 1985 interview that the late investor Walter Schloss did with business publication Barron’s. Schloss’s thoughts on investing are well worth noting, in my opinion. According to the book Value Investing: From Graham to Buffett and Beyond, which is co-authored by Columbia Business School finance professor Bruce Greenwald, Schloss’s investment firm had generated compound annual returns of 15.3% from 1956 to 2000. The U.S. stock market, in comparison, had climbed by ‘just’ 11.5% per year over the same period. A lesson from history The Barron’s interview, which I’d highly recommend to all…
I had recently chanced upon an old 1985 interview that the late investor Walter Schloss did with business publication Barron’s.
Schloss’s thoughts on investing are well worth noting, in my opinion.
According to the book Value Investing: From Graham to Buffett and Beyond, which is co-authored by Columbia Business School finance professor Bruce Greenwald, Schloss’s investment firm had generated compound annual returns of 15.3% from 1956 to 2000. The U.S. stock market, in comparison, had climbed by ‘just’ 11.5% per year over the same period.
A lesson from history
The Barron’s interview, which I’d highly recommend to all (here it is again), contains a boatload of investing lessons from Schloss. But in here, I’d like to focus on just one: The importance of acknowledging that conditions in the stock market can change at times in a near-permanent manner so as to severely blunt the usefulness of historical experience.
Here’s Schloss on the matter in the Barron’s interview (emphasis mine):
“Graham [referring to investing great Benjamin Graham] used to have this theory that if there were no working capital stocks around, that meant the market was too high…
… [That’s] because historically, when there were no working capital stocks, the market collapsed. That worked pretty well till about 1960, when there weren’t any working capital stocks, but the market kept going up. So that theory went out.”
For some perspective, the S&P 500 (a broad market index in the U.S.) was trading at 60 points at the start of 1960; it’s at more than 2,000 today.
There are more examples of how investors can be left in the cold if they had stuck to antiquated valuation models without realising that a new era has arrived. For instance, in the first half of the 20th century, the dividend yield for stocks in the U.S. had been higher than bond yields most of the time. When dividend yields dipped below bond yields, the stock market promptly crashed.
But, in the 1950s, bond yields started climbing above dividend yields. And, it stayed that way until the late 2000s when the two yield figures started converging.
An investor in the 1950s who wanted to invest based on the historical relationship between bond yields and dividend yields in the first-half of the 1900s would not have had any chance at all to invest for decades. And yet, the S&P 500 has jumped by 55-fold in price alone from the start of 1955 to today.
As you can see, markets do change – and investors have to adapt.
Taking it further
The central lesson here about the limits of using historical valuation data on the stock market as a whole can be applied to individual stocks as well.
Right now, in Singapore’s stock market, blue chip stocks – the 30 stocks that make up Singapore’s market barometer, the Straits Times Index (SGX: ^STI) – such as SembCorp Marine Ltd (SGX: S51), Noble Group Limited (SGX: N21), Keppel Corporation Limited (SGX: BN4), and Golden Agri-Resources Ltd (SGX: E5H), are all carrying price-to-book (PB) ratios that are far lower than their respective historical averages over the past five and 10 years. You can see this in the table below:
The following chart, which plots the evolution of the PB ratios for the quartet of stocks over the past decade, also makes it clear that they are all currently trading at the lower end of their historical value ranges.
It’s easy for investors to look at this information and conclude that the quartet of stocks are bargains now simply because they are all carrying low valuations in relation to history. But, it’s worth considering if anything has permanently changed.
Bankruptcy risks. Industry obsolesce. Incompetent management. Absurdly high valuations in the past. The appearance of these factors and more in a company may result in its future value being irreparably eroded such that its past valuation data are no longer relevant.
A Fool’s take
Investors love to look at historical valuation numbers when studying the markets, myself included. But when doing so, it’s crucial that we keep in mind that things can change and that what has worked in the past may no longer be valid in the future. We have to be aware of times when the use of history becomes dangerous in investing.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any companies mentioned.