Volatility is the friend of the Value Investor (2)

Volatility is the friend of the Value Investor (2)

September 3, 1929:
DJIA hit a historical high of 381.17
Seven weeks later, stocks crashed. The next 34 months saw the most devastating decline in share values in U.S. history.

July 8, 1932:
The carnage was finally over. DJIA stood at 41.22.
The marke value of the world's greatest corporations had declined an incredible 89%.
Millions of investors' life savings were wiped out.
Thousands of investors who borrowed money to buy stocks were forced into bankruptcy.
America was mired in the deepest economic depression in its history.


LESSONS FOR THE LONG-TERM VALUE INVESTOR

In summer of 1929, a journalist interviewed John J. Raskob, a senior financial executive at General Motors, about how the typical individual can build wealth by investing in stocks. Raskob claimed that America was on the verge of a tremendous industrial expansion. He maintained that by putting $15 a month into good common stocks, investors could expect their wealth to grow steadily to $80,000 over the next 20 years. Such a return - 24% per year - was unprecedented, but the prospect of effortlessly amassing a great fortune seemed plausible in the atmosphere of the 1920s bull market. Stocks excited investors, and millions of people put their savings into the market seeking a quick profit.

On September 3, 1929, a few days after Raskob's ideas appeared, the Dow Jones Industrial Average hit a historic high of 381.17. Seven weeks later, stocks crashed. Raskob's advice was ridiculed and denounced for years to come. It was said to represent the insanity of those who believed that the market could rise forever and the foolishness of those who ignored the tremendous risks inherent in stocks.

Conventional wisdom holds that Raskob's foolhardy advice epitomizes the mania that periodically overruns Wall Street. However, is this verdict fair? The answer is a decidedly no.

If you were to calculate the value of the portfolio of an investor who followed Raskob's advice, patiently putting $15 a month into stocks, you would find that:

• his or her accumulation would exceed that of someone who placed the same money in Treasury bills after less than 4 years!
• after 20 years, his or her stock portfolio would have accumulated to almost $9,000, and
• after 30 years, over $60,000.

Although not as high as Raskob had projected, $60,000 still represents a fantastic 13% return on invested capital, far exceeding the returns earned by conservative investors who switched their money to Treasury bonds or bills at the market peak. Those who never bought stock, citing the great crash as the vindication of their caution, eventually found themselves far behind investors who had patiently accumulated equity.

An important theme in the history of Wall Street is not the prevalence of foolish optimism at market peaks; rather, it is that over the last century, accumulations in stocks have always outperformed other financial assets for the patient investor. Even such calamitous events as the great stock crash of 1929 did not negate the superiority of stocks as long-term investments.