Common Stocks as Long Term Investments

I just finished reading Common Stocks as Long Term Investments by Edgar Lawrence Smith. Refreshing!Smith sets out to prove the received wisdom of the day, that bonds outperform stocks, but the results of the research didn't bear out the conventional wisdom. In all but one of the "tests" stocks beat bonds and in some cases quite handsomely.Despite the difficulty of obtaining data, Smith manages to construct an 85 year long stock market index from 1837 to 1923. The importance of such a long term chart is that it clearly shows the exponential nature of the growth of the market. By fitting a curve to the low points and another to the high points, Smith shows that the market was growing at approximately 2.5% annually. Should this number seem low by present standards, please take into account that back then stocks paid handsome dividends, typically between 4 and 8 per cent per annum as otherwise stocks would not be purchased in preference to bonds.The chart constructed by Smith looks very similar to any modern day stock chart, lots of volatility. Smith then analyzed what he calls "The time hazard in the purchase of common stocks" how long it would take to break even no matter when you bought your shares and the worse case scenario was 15 years, considerably less that the period Jeremy J. Siegel found in his study Stocks for the Long Run. Essentially Smith and Siegel found the same thing, a patient enough investor won't ever lose money in the market provided the portfolio is well diversified and holds the largest companies in the various leading industries.Smith then sets out to find out why it is that stocks beat bonds as long term investments. His three major conclusions are:First: inflation is more likely than deflation and bonds don't have any protection against inflation. In inflationary times bonds lose purchasing power even as the face value remains the same. Stocks, to the contrary, grow in value often beyond inflation as I will explain below.Second: for a bond to qualify as high grade, the issuing company has to have earnings above and beyond what is required to pay off the interest and the principal of the bond and this extra income accrues to the stockholders, not to the bond holders.Third: population growth requires growth of products and services and the companies that provide them grow accordingly. Improving standard of living has the same effect, people demand more and better products and services and the companies supplying them grow accordingly. This growth is above and beyond inflation as otherwise there would be no improvement in the standard of living, quite the contrary.Earlier I called the work refreshing because it goes back to first principles instead of relying on the hocus-pocus of charting and complex crystal ball gazing. In essence, when you own stocks you own a piece of the productive capacity of your country and, if the economy is growing, so does this productive capacity.Where Smith falls short is in his stock picking. He talks generally about "investment management" but does not offer a superior method of picking stocks. His "tests" were based on generic methods so as not to induce bias: "In the test that follow, the only principle of sound investment that has been applied to the selection of stocks is that of diversification. Without diversification, the purchase of common stocks cannot be considered." That task, better stock picking based on price charts, was left for BuildMWell to discover. Smith looked at the tops of the price index chart to determine how patient an investor would have to be. On the contrary, BuildMWell looked at the bottoms of the price index chart and came to the brilliant conclusion that if these were indeed the bottoms then there was no better price point at which to buy.

Written a long time ago - comparing the performance of stocks vs bonds over time - goes into the nature of what it actually means to hold a stock vs bond. Although this information isn't new to me, it should be required reading for anyone seriously investing. I would actually give 4.5 starts. With half a start deduction for not being as concise as I would like.

The book, probably the first of its kind, is a fascinating study of the state of investment attitudes towards stocks and bonds in the many decades leading up to 1923, and how the prevailing wisdom of the time leaned almost exclusively towards high-grade bonds, with common stock ownership being viewed as highly speculative and not being able to outperform bonds over the long term.As such, the 11 Case Studies show how a common stock investor was able to handily outperform bonds over the 1866 to 1923 period in all but one Case Study, and even that was a narrow loss relative to Bonds during the 20 year period in question.In addition, the book also addresses the effects of massive US currency deflation (from 1866 to 1897) and inflation (from 1898 to 1923) on the relative adjusted returns of both types of securities, and shows how common stocks retained their purchasing power in most of the Case Studies during the inflationary period (and both gained during deflationary times), whereas bonds fell short during the inflationary period.The only glitch I've seen so far is that page 8 is missing, because page 6 was repeated twice. Hopefully the Publisher can correct this in future print runs.

Common Stocks As Long Term Investments ...by Edgar Lawrence SmithThis book has been cited as one cause of the Great Depression because it led to overconfidence in US investors in the safety in investing. If you read Smith's superb book and his very scientifically based back-testing you will not get the impression that Smith is advocating taking out huge margins and you will be rich in no time flat. Is is merely showing that stocks much to his surprise outperform bonds over long periods of time. His results have been replicated endlessly and the results hold up over time. Excellent read.Victor Lee Burke

This book contains numerous well constructed historic studies covering the period 1866 to 1923. It demonstrates that over long periods of time stocks always return more than bonds. This was true even in the period from 1866 to 1900 when the US had massive deflation and he dollar's buying power increase three fold.

I use this book for personal use. I like knowing the reason for stock price increase in the long run.

This book perfectly show how stock market investment system works in a long run. Short term trading is totally mind boggling.

It's great that folks are doing reprints of these classics. This book in particular should be much more widely known I think. The reproduced text is clean and clear, including tables and graphs.