New Material In The Fourth Edition

The fourth edition not only updates all the data from the third edition, but it also introduces completely new material on such topics as which stocks have done well in the long run and what will be the distribution of world output and equity values in the middle of this century. A whole new chapter has been added on the history of the firms in the S&P 500 Index, which celebrated its fiftieth anniversary in March 2007.

A recurring theme in this edition of Stocks for the Long Run is that "growth does not imply return." This principle can be applied to individual stocks, industries, and even countries. I show the superiority of high-dividend-yield and low-P-E strategies for the stocks in the S&P 500 Index. Sector growth turns out to play only a minor role in determining returns. These findings support the conclusion that value stocks outperform growth stocks in the long run, a phenomenon that has been well documented in the finance literature.

In the preface to the 2002 edition of Stocks for the Long Run, I wrote, "Although I still believe that [capitalization-weighted] indexed investments should constitute the core of every investor's long-term portfolio,

. . . [s]ome indexes, such as the Standard & Poor's (S&P) 500 Stock Index, have become so popular that entry to the index carries with it a price premium that may reduce future returns."

Further research has supported this contention. The chapter on the history of the S&P 500 Index shows that the new firms added to the index have generally had lower returns than the original firms that were chosen in 1957. In this edition, I introduce the "noisy market hypothesis," an alternative to the efficient market hypothesis that explains why value stocks outperform growth stocks. In Chapter 20, I describe "fundamentally weighted" indexes as an efficient alternative to capitalization-weighted indexes for capturing the value premium.

Any analysis of the stock market today must be international in scope, and in this edition I have greatly expanded the material on international markets. I detail the role of the developing economies in mitigating the aging crisis that will soon envelop the United States, Europe, and Japan as the ranks of retirees swell. I believe that Asia and other developing countries will, by the middle of this century, play a dominant role in the world's economy and capital markets. I conclude that Americans face a crucial choice—allow the influx of foreign capital or face poor financial returns and a far more difficult retirement period.

All this makes investing in international equities not only important but critical to developing a comprehensive investment strategy. The chapter on global economics shows that despite the increased short-term correlation between country returns, global diversification is still an essential part of today's investment strategy. Without doubt, the portion of the world's equity capital that is located outside the United States will grow rapidly in the coming years.

The fourth edition also reevaluates the findings reported in the previous editions. Such topics as calendar anomalies (for example, the January Effect), the impact of Fed interest rate changes on the stock market, and the importance of investor sentiment in predicting future market returns are given a new look. I determine whether there have been any systematic changes in the response to these factors since the first edition of Stocks for the Long Run was published in 1994.

There are some surprising results: some of the calendar anomalies hold up very well while others disappear altogether. For example, Fed rate cuts, although having a powerful immediate impact on stock prices, do not have as predictable an intermediate-term impact as they once had. Other topics examined include the "Gordon model" of stock valuation and economic growth, the increasing advantage of exchange-traded funds over mutual funds, momentum investing, and why many "bears"

have misinterpreted historical evidence on dividend growth and corporate profits.

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