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The Nifty 50 Were Worth Their High Price

   

Many cheapskate investors, including Ax and uncle Howard of Max's Investment World, believe that growth stocks, or stocks with high price-to-earnings are often too expensive to have much of a payoff. Growth stocks generally experience sharp increases in sales and income. When investors see how fast these companies are growing, they buy them at stratospheric prices, which don't have much upside potential.

But some high flyers are worth it, according to Jeremy Siegel, a professor at the University of Pennsylvania. Siegel went back and looked at the Nifty 50, which were the growth stocks that any self-respecting investor just had to have in the early 1970s. The group included such blue chip names as PepsiCo, McDonald's, Philip Morris, Upjohn, General Electric and Minnesota Mining & Manufacturing.

Siegel argues growth stocks experience periods of under- and overvaluation, that is a period when their stock price is too low or too high relative to what they will return but that over 20 years or more, they perform quite well.

He found that from December 1970 to December 1972, the Nifty 50 became quite expensive as everybody just had to own them. Adjusting for risk and tax advantages, these stocks went from being undervalued by 31.5 percent in 1970 to being undervalued by only 7.4 percent in 1972. After the collapse of stock prices in 1974, the nifty 50 were undervalued by 15.1 percent after adjusting for risk and tax benefits and sometimes they were undervalued by as much as 30 percent up until 1980. In the 1980s, the nifty 50 came back and posted stellar returns well above most stock indices (just think of General Electric under the reins of CEO Jack Welch, for example).

"Large growth stocks can indeed be worth upward of forty to fifty times earnings," Siegel wrote in his study. "PepsiCo, Disney, Philip Morris, and Coca-Cola had warranted price-to-earnings ratios well over 60 times earnings in 1972." According to their future performance, the nifty fifty had and should have had a price-to-earnings ratio that was twice that of value, or low price-to-earnings, stocks.

Bottom line: if you hold on a large growth stock long enough, you probably will do pretty well.

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