An article appeared in The Telegraph over the weekend looking at the extended bull market in consumer stocks and their valuations. Whilst high quality consumer stocks are certainly in a raging bull market, what was interesting in the piece was that the author used The Nifty Fifty as an example of what can happen when investing during periods of high valuation.
The original Nifty Fifty was a group of large cap stocks in the 1960’s and 1970’s that were billed as perfect buy-and-hold forever types. Combine that with the raging equity bull market of the time (and the fact they were all solid growth stocks as well) and you got the recipe for some really lofty valuations. We’re taking price-to-earnings ratios of 40, 50 and even 60x annual profits for certain household stocks like Johnson & Johnson. The implication of the article was that investing in the euphoria of that bull market was a bad idea due to the poor returns experienced in the bear market that followed.
Whilst it’s true that an investment the Nifty Fifty would have shown poor returns in the immediate years following the early 1970’s, the article is also guilty of cherry picking to make its point. In reality the Nifty Fifty is a perfect example of how investing in high quality blue chip stocks will yield great returns in the long run. The thing I like best about it is that it covers so many different themes in one go. Concepts like value, growth, quality, diversification and the importance of having a long term horizon are all key investing lessons from the experience of this group of stocks.
Let’s start by turning the clock back to August, 1972. Richard Nixon was finishing his first term as the 37th President of the United States, ground combat troops were withdrawing from Vietnam and Walmart had just started trading as a public stock on the New York Stock Exchange. Let’s imagine a $100 investment in each of the Nifty Fifty shares. Among the holdings would be companies such as Coca-Cola, Walmart and McDonald’s. In total the investment would amount to $5,000 in 1972 money, which is the equivalent of $28,000 today. Remember it’s the change in purchasing power which is the most important point when comparing investment returns.
There’s no official list of the original Nifty Fifty as far as I can determine, each publication differing slightly in the composition, but for the purposes of the demonstration it doesn’t matter too much. It’s fair to assume that there were exactly fifty companies and our investor evenly distributed his $5,000 starting capital between them.
The first theme that is evident from the history of the Nifty Fifty is diversification. No matter how high quality a company is there is always a risk that one day it will go bust. That might be down to industry disruption, poor management, financial crises or anything else for that matter. The risk is always there.
The best example of this from the original group of Nifty stocks is Eastman Kodak Corporation. Kodak’s business was once every bit as stodgy as some of the high quality blue-chips trading today, and the camera brand was known in households across the globe. Eventually though the advent of digital technology made the business obsolete. An extremely profitable and high quality stock was reduced all the way to nothing. There are other Nifty Fifty stocks that met the same fate, but in the end the diversification among other high quality companies more than offsets the damage of a few big losses.
In fact, let’s just examine the returns of the three stocks mentioned above: Coca-Cola, Walmart and McDonald’s. Let’s completely ignore the performance of the other shares that made up the list and see how that $300, $100 in each share, did from the early 1970’s.
You probably won’t be surprised to read that they have done pretty well in that time frame. They are all still going strong today, and they are all very profitable companies. $100 worth of Coca-Cola stock purchased in 1972 would be worth $6,110 today. $100 worth of McDonald’s stock bought in 1972 would today be worth $8,990. In the case of Walmart $100 worth of stock picked up in 1972 would be worth a massive $107,429 today. That’s not a typo by the way – Walmart returns really have been that spectacular.
The after inflation return factor on the $5,000 capital is 4.5 fold. That’s excluding the other 47 stocks and excluding the contribution of the thousands of dollars in dividends that would have been paid over the years. For this year alone the 137 shares of Coca-Cola stock would generate $189 in annual dividend income. The 70 shares in McDonald’s would throw off $240.80 in annual dividends. Amazingly the 1,552 shares accumulate in Walmart stock would pump out $3,041 in annual dividend cash.
That’s just three stocks out of the fifty or so that we started with. That’s ignoring the great compounding stocks like Walt-Disney, Procter & Gamble, Philip Morris and PepsiCo that would have enhanced the returns even more. It’s ignoring all of the dividends that would have been paid over that nearly 45 year time frame too. Of course there are some bad performers, even some total wipeouts like Eastman Kodak.
The diversification, and picking up a few big winners, more than makes up for it. This is partly why investors shouldn’t fear the kind of nasty bear markets that would have affected the Nifty Fifty back in the 1980’s, or the financial crises of 2000 and 2009. As long as there is good degree of diversification among high quality companies the risk of permanent capital impairment is minimal.
What’s also interesting is the role that value played in the subsequent returns. During the bull market years Nifty stocks were trading as high as 50-60x their earnings. Growth rates were obviously a lot higher back in the 1970’s than they are today, but it shows that a portfolio containing very high quality holdings will ultimately deliver strong returns if left for long enough. Needless to say the returns would have been magnified if an investor had bought even more shares when the valuations dropped in the following years.
On average though those fifty or so stocks did end up justifying their high valuations, with the few big losers more than being made up by the big winners like Walmart.
There will always be very volatile periods when holding stocks, as any investor who witnessed 70%+ loses on some of those Nifty Fifty shares will know. The overall lessons though are clear. Stick to high quality blue chips and ensure you are adequately diversified. Most importantly, be prepared to hold for the long haul. Investors who follow those principles will, in all likelihood, generate substantial wealth that the original Nifty Fifty are now famous for.