Cover image for Dow 36,000 : the new strategy for profiting from the coming rise in the stock market
Dow 36,000 : the new strategy for profiting from the coming rise in the stock market
Glassman, James K.
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First edition.
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New York : Times Business, [1999]

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x, 294 pages ; 25 cm
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HG4915 .G55 1999 Adult Non-Fiction Central Closed Stacks

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Contrarian . . . controversial . . . compelling . . . practical This book will liberate investors from conventional wisdom and change the way everyone thinks about stocks and investing. What's the message investors have been getting from media pundits and so-called market experts? "Stocks are in the stratosphere. . . . They're risky. . . . We're headed for a fall." Jim Glassman and Kevin Hassett heard this message for years but wondered why the opposite kept happening. Instead of declining, the prices of stocks kept rising. Was financial gravity being defied, or were other forces at work? Were investors being frightened away from profits they could be enjoying from a market that will continue to boom? Dow 36,000 is the result of Glassman and Hassett's investigation. It is one of the most important and provocative books on markets and investing written in recent years. Its original and compelling analysis and practical program for profiting from the continuing rise in the stock market are ideas that every investor--from neophytes to the most experienced--must understand and act on now. ¸  Stocks are undervalued, not overvalued. Stock prices will double, even quadruple, within a short period of time. The Dow Jones Industrial Average will soon reach 36,000. Astounding profits can be made, but the time to act is now! Dow 36,000 tells why this one-time rise is coming and how to adjust your portfolio and invest without fear. ¸  The perfectly reasonable price. Prices are too low because investors and Wall Street have been looking at stocks the wrong way: at valuation levels of the past (the traditional ceiling of the price/earnings ratio, for example). Dow 36,000 provides a new model--a new way of valuing the worth of any stock by figuring out how much money it will put in an investor's pocket. ¸  How to invest with confidence. Glassman and Hassett provide investors with a sensible strategy for making money by becoming a disciplined "36er." Their practical advice tells why many investors should not be active traders and why it's important to hold on to stocks and mutual funds even when they go into a downturn. ¸  A practical program to maximize your portfolio. Glassman and Hassett provide their picks for the best stocks and mutual funds, but just as valuable are their ideas on how to think about the kinds of stocks and mutual funds that will help earn the most money. Examples include not only such stocks as Cisco Systems, Microsoft, and GE, but many you may not have thought of, including Tootsie Roll and Biogen. Investors have long needed a new way to understand what is happening in the stock market. Dow 36,000 provides that understanding. It is the new paradigm.

Author Notes

James K. Glassman is a "Readers Digest" columnist, a fellow at the American Enterprise Institute, a regular commentator on National Public Radio, & a former columnist for "The Washington Post." Glassman lives in Washington, D.C.

(Bowker Author Biography)

Reviews 2

Booklist Review

The Dow Jones industrial average is the stock market indicator most often watched by investors and pundits alike. If it continues at its present five-year pace, it is due to crash the 33,000 mark in 2004. Glassman and Hassett ask, though, "Why wait?" Both authors are affiliated with the American Enterprise Institute, a conservative think tank. Glassman wrote an investment column for the Washington Post, but he has since left to do consulting. Hassett is a former economist for the Federal Reserve. Last year they wrote a provocative piece for the Wall Street Journal, tweaking Federal Reserve chairman Alan Greenspan and arguing that stocks were undervalued by as much as a factor of four. Their book elaborates their case, which claims that the use of such historical measures as dividends and price-earnings ratios are no longer valid and that stocks are no more risky than Treasury bonds. They present a new model to determine a stock's "perfectly reasonable price." Kadlec, an investment strategist with Seligman Advisors, is even bolder. He asserts that the Dow will peak 100,000 by 2020. To do so would require a sustained 11.1 percent annual rate of advance. This will be possible, Kadlec argues, because the end of the cold war has resulted in global stability, baby boomers are increasingly saving for their retirement, technological advances have lead to increased productivity, the spread of freedom worldwide has led to widespread prosperity, and governments still must continue to compete economically. Kadlec does offer several caveats, emphasizing that the signposts to watch are tax rates, inflation, and trade policy. Both of these books will surely attract investors and stir skeptics. --David Rouse

Publisher's Weekly Review

The only thing missing from this half-time speech of an investment book is an exhortation to buy stocks for the Gipper. Despite the sensationalist title, Glassman, a syndicated columnist, and Hassett, a scholar at the American Enterprise Institute who used to be an economist at the Federal Reserve, argue only the classic case for investing in stocks: that over long periods of time stocks have always outperformed alternative investments. But no motivational device is spared to make this case more strongly than it has ever been made before. Experienced investors will wince at the simplification and overstatement as the authors, in their effort to obliterate the arguments of anyone who has ever suggested that stock prices might actually fall, brush aside considerations like risk, dividend yields and price-earnings ratios. These and all other objections are downed out by the drumbeat of Dow 36,000! How do they arrive at this number? In several different ways, none of which is described in detail. Over long periods of time the Dow goes up, with inflation if nothing else. In the last two decades, it has been rising at a rate that makes it triple every seven years. So predicting that the Dow will triple eventually is not saying much. The key question for investors is, will it triple fast enough to make stocks an attractive investment? Here the authors fall into confusion, suggesting, in the space of seven pages, that it could happen in three years or 10 years. This last prediction implies that the stock market will actually do worse in the next decade than it has in the previous two. Agent, Rafe Sagalyn. First serial to the Atlantic Monthly; BOMC alternate selection; Money Book Club main selection; 5-city author tour. (Sept.) (c) Copyright PWxyz, LLC. All rights reserved



Chapter One Introduction: Why Stocks Are Such a Good Buy I have steadily endeavored to keep my mind free so as to give up any hypothesis, however much beloved (and I cannot resist forming one on every subject), as soon as facts are shown to be opposed to it. --Charles Darwin (1809-1882) NEVER BEFORE have so many people owned so much stock. They depend on their shares not just to enjoy a comfortable retirement, but also to pay tuition, to buy a house or a car, to help their children, to take a long vacation, or simply to lead a good life.     Today, half of America's adults are shareholders--up from one-fifth in 1990 and just one-tenth in 1965. Stocks are the largest single asset that families own, topping even the net value of their homes.     But investors--many of them novices--are as frightened as they are enthusiastic. The market has been a great boon, but it remains a great and ominous mystery.     It should not be. This book will give you a completely different perspective on stocks. It will tell you what they are really worth--and give you the confidence to buy, hold, and profit from your investments. It will convince you of the single most important fact about stocks at the dawn of the twenty-first century: They are cheap. A ONE-TIME-ONLY RISE Throughout the 1980s and 1990s, as the Dow Jones industrial average rose from below 800 to above 11,000, Wall Street analysts and financial journalists warned that stocks were dangerously overvalued and that investors had been caught up in an insane euphoria.     They were wrong.     Stocks were undervalued then, and they are undervalued now. Tomorrow, stock prices could immediately double, triple, or even quadruple and still not be too expensive.     Market analysts and media pundits have also persistently warned that stocks are extremely risky. About this, they were wrong too. Over the long term, stocks, in the aggregate, are actually less risky than Treasury bonds or even certificates of deposits at a bank.     While the experts may not be very good at predicting what the market will do, they are brilliant at scaring people--not out of malice but out of a profound misunderstanding about stock prices. Whatever their intentions, they have performed a disservice to millions of investors by frightening them away from the market.     If you own stocks or mutual funds, this book will remove the fear.     If you are worried about missing the market's big move upward, you will discover that it is not too late.     Stocks are now in the midst of a one-time-only rise to much higher ground--to the neighborhood of 36,000 on the Dow Jones industrial average. After stocks complete this historic ascent, they will still be profitable, but their returns will decline. You won't be able to make as much money from them each year. In the meantime, however, astounding profits will be made. This book will show you how easy it is to participate.     Many small investors are already catching on. They have ignored the dire warnings from professionals that have accompanied nearly every step of the Dow's rise from 777 on August 12, 1982. They are rejecting the outdated model that Wall Street has been using to assess whether stocks are overvalued--a model based largely on historical price-to-earnings, or P/E, ratios. That rejection reflects not their nuttiness but their sanity. After all, the stock market itself long ago repudiated the model. Contrary to the famous warning of Federal Reserve Board Chairman Alan Greenspan--made on December 5, 1996, with the Dow at 6437--investors are not irrationally exuberant, but rationally exuberant. They have bid up the prices of stocks because stocks are a great deal.     Still, even the most enthusiastic investors have doubts. They know vaguely that stocks are wonderful, but they have no real framework for analysis. They don't have an explanation for why prices are going up and up.     We do.     How did we come to hold our views? We began nearly three years ago by wondering what on earth was going on in the market. Stocks had quintupled in price in the dozen years up to 1994. Then, in 1995, 1996, and 1997, the Standard & Poor's 500-stock index, generally considered a good proxy for all U.S. stocks, scored returns of more than 20 percent. ("Returns" means dividends plus "capital appreciation," which is a fancy name for the increase in a stock's price.) Never before in modern history had the market had three years this good in a row.     Why were prices rising so quickly and consistently? We weren't satisfied with the explanations we heard in the press and on Wall Street: that investors were acting irrationally--reflecting what Charles MacKay called, in the title of his 1841 book, Extraordinary Popular Delusions and the Madness of Crowds --or that baby boomers all of a sudden remembered they should invest for retirement and decided to dump huge sums into stocks as protection against a penurious future.     No. There had to be better answers. THE RIGHT PRICE We decided to begin with the core question. If the issue was whether the market was overvalued, we wanted to know this: What is the right price for a stock?     The experts did not have an answer. Their model--or view of the financial world--typically focused on what are called "valuation indicators," such as the P/E ratio. Wall Street analysts figure that, if P/Es are too high, stocks are overpriced.     But the term "too high" relates only to history--not to substance. We decided, first of all, to look at substance. At dollars. At how many dollars a stock puts in your pocket over time.     As John Burr Williams, a brilliant young economist with the ability to cut through the muck, wrote in 1938, "In short, a stock is worth only what you can get out of it [his italics]."     So, first, we developed a method for estimating the flow of cash an investor can get from a stock. Next, we determined what that cash flow was worth.     A house that throws off $1,000 in rental income a month might be worth, say, $150,000. A restaurant that generates $100,000 in profits a year might be worth $1 million. What, then, is a share of IBM worth? What is the "perfectly reasonable price"--or, as we put it, the PRP--for any share of stock?     In our research, we were shocked at how high PRPs turned out to be. Could it be possible? After refining our analysis for a year, listening to the criticisms and suggestions of people we trust, we became convinced that our theory explains--as no other theory does--the rise in stock prices over the past two decades. More important, we concluded that the rise will continue, at least until Dow 36,000.     You will find, after reading this book, that you can determine the right price for any stock. But if analyzing individual companies is too time-consuming or unappealing, we will show you how to construct a portfolio of mutual funds that will accomplish much the same purpose.     But picking the right stocks and funds does not guarantee success. More important than your selections is what you do after you make them. We will show you how to build a personal relationship with your investments so that you are less likely to act rashly--and unprofitably--in a volatile market.     The reason to invest in stocks immediately is that changes are afoot that will cause shares to rise powerfully toward their true value, their PRP. Stocks, of course, will not go straight up. They never do. There will be dips, possibly even brief bear markets, along the way. Those declines will provide great buying opportunities--but only for investors who know what stocks are really worth. THE POWER OF DIVIDENDS For too long, the value of stocks has been seriously underrated.     Consider dividends, which are the part of a company's earnings that it gives out in cash, usually in the form of quarterly checks, to its shareholders. Most stocks today pay what the experts say are paltry dividends. But the truth about dividends is that they increase as earnings increase--and over time, these increases compound so that even tiny dividends today will provide shareholders with loads of cash in the long term.     Take General Electric Co., a giant diversified corporation with interests ranging from lightbulbs to broadcasting to jet engines to plastics to consumer finance. GE is superbly managed but hardly the sort of fresh, go-go business associated with parabolic growth. After all, it is more than a century old. In Chapter 13, we will closely examine GE, but here are the highlights on the company's dividends.     First, we took the price of GE in 1989 and adjusted it for splits that occurred later. (When a company splits its stock, it issues new shares to current owners, but the value of their total holdings does not change. For instance, if you own 100 shares with a market price of $100 each, and the stock splits two-for-one, you will own 200 shares with a market price of about $50 each.)     In 1989, you could have bought a share of GE for $11, after accounting for splits. At the time, the stock was paying an annual dividend of 41 cents, or 3.7 percent of the share price. The dividend rose each year, so that, by the start of 1999, it was $1.40--or more than three times the annual dividend ten years earlier.     In other words, in 1999, your GE stock was paying you a dividend return--in that year alone--of 12.7 percent on your original investment, or well over twice the rate of a ten-year Treasury bond, and rising. At this pace, in another twenty years, GE will be paying an annual dividend that represents a 50 percent return on your initial investment!     GE is a profitable company that passes on its gains to shareholders, but it is not exceptional. In the year 1999 alone, dividends on a share of Philip Morris exceed the stock's 1980 purchase price.     This is the difference between what bonds and stocks put into your pockets: Bonds may make higher interest payments to start, but over time stocks outstrip them because the profits of healthy firms increase, and so do their dividends.     For example, over the twenty years starting in 1977, a $1,000 investment in American Brands, a modest consumer products company that later sold some divisions and changed its name to Fortune Brands, put five times as much money (in dividends alone) into the pockets of its shareholders as a $1,000 investment at the same time in a long-term Treasury bond.     Our research found that, since 1946, dividends have risen, on average, more than 6 percent a year. The after-tax earnings that companies report to shareholders have risen more than 7 percent. Something growing that fast doubles about every ten years through the miracle of compounding.     Those growth rates are at the heart of our theory about rising stock prices. They have largely been ignored by analysts, who prefer to judge stocks by backward-looking valuation techniques that, much of the time, have argued against investing in stocks at all.     The measures you see in the stock tables and hear mentioned on television have been so wrong for so long that it is hard to see why anyone continues to pay attention to them. But old ideas die hard. THE EMPIRE STRIKES BACK New ideas, on the other hand, disturb.     On March 30, 1998, we unveiled our theory in The Wall Street Journal under the headline, "Are Stocks Overvalued? Not a Chance." At the time, the Dow stood at 8782, and we said we were comfortable then, as now, with the index rising to 36,000 or even higher.     The article provoked criticism because it challenged the cherished assumptions of the financial establishment--for example, that dividend yields of 2 percent are too low and that P/E ratios of 25 are too high. But the truth is that clinging to the conventional wisdom can be very costly to investors.     (Don't worry. We'll explain all the jargon. For example, a "price-to-earnings ratio" indicates how many dollars an investor has to pay today for one dollar's worth of a company's profits. The average P/E since 1872 has been 14. A high P/E indicates that a stock is popular--some would say too popular--with investors.)     At the same time, our views have led some professionals to begin reconsidering the old rules of the stock market. After our Wall Street Journal piece, Byron Wien, the respected Morgan Stanley strategist, wrote a letter to his clients laying out our arguments--for example, that "the fair-market P/E multiple of the market could reach 100." The article, he said, "did start me thinking."     It's smart to be skeptical when someone (like us) claims that "this time it's different"--that something new is happening in the stock market. But, as Wien points out, there have been times "when recognizing that something was, in fact, different paid off significantly."     Still, a more common response to our ideas by the financial establishment was anger and resentment. Following our second piece in The Wall Street Journal --on March 17, 1999, just after the Dow passed 10,000--Bob Brusca, then chief economist at Nikko Securities, was quoted in the New York Post as saying "This stupid article does not make any sense."     He's right. It doesn't make sense if you are stuck with the model that has dominated Wall Street, the media, and academia for the past half-century or so. But that model clearly has not worked. Even its supporters are shaking their heads in disbelief. "We're at an unusual point in history," said Robert Shiller, the Yale economist, at the start of 1999. "Historically, after a period of success on the stock market, the price goes back down. Currently, it's a little uncomfortable because it has never gotten this out of whack." Back in 1996, Shiller told the governors of the Fed--the Federal Reserve Board--that stocks were dangerously high and headed for a fall. But, in the next three years, share prices continued to rise at a record pace. The problem is not the insanity of investors but the inadequacy of the old models. Today's professionals measure stock prices against particular yardsticks of history and say they are far too high. But there is another way to value stocks--and it indicates clearly that prices are far too low. THE USES OF HISTORY You can learn a lot from the past. For instance, research shows that stocks have been incredibly generous to the people who have bought them, returning an average of 11 percent a year--including both dividends and price increases--since 1926. If those averages hold and you keep reinvesting your dividends, you will double your original stake in six and a half years. And, in less than twenty years, $10,000 will grow to $80,000.     But history can also become tyranny. Just because something has happened in the past doesn't mean it will keep happening in the future. Maybe it has rained three days in the row. That doesn't mean you need to build an ark. To move from observations of history to faith in the future requires knowledge. You need to know whether you are looking at the right facts from the past.     When it comes to stocks, the financial establishment chose to look at a particular slice of history and conclude that valuations have a low ceiling. (A "valuation" is a number that measures what a stock is worth since the raw price of a stock alone doesn't tell you much.) According to this view, if the ratio of a stock's price to its earnings--the P/E ratio--gets too high, the price will inevitably collapse or, as economists say, revert to the mean.     But why? It is not enough simply to answer, "Well, that's the way it has always been."     What if something has changed to raise the historic "ceiling" on the P/E ratio? What if the low ceiling was the result of irrationality or ignorance? And what if investors have become more rational and intelligent?     But on Wall Street, the iron-clad rules of history seem to permit no change. On January 18, 1999, Barron's , the financial weekly, published a transcript from a discussion among nine strategists and money managers invited to give their forecasts. The participants concluded, as they had in the previous three years, that the market was overpriced bur that individual bargains could be found. (Without such discrete bargains, of course, the money managers might as well close up shop.) The main message, though, was "overpriced." The headline on the article was "Tulipmania," a sly reference to the seventeenth-century pandemonium--discussed in more detail in the next chapter--that pushed the prices of Dutch tulip bulbs into the stratosphere before they crashed back to earth.     Typical was the remark of panelist Oscar S. Schaefer of Cumberland Associates in New York: "If you look at stock valuations on a historical basis--especially big companies'--there is nobody who will now not say that they are overpriced."     Schaefer actually had it right. Looking at valuations through the telescope of history--or, more precisely, from a specific historical vantage point--you would have to conclude stocks were overpriced. And all nine of the roundtable participants agreed--as does practically every other observer of the financial scene.     While they were right in their observation of history, they were wrong in their conclusion. It doesn't matter what the price, or the valuation, was ten years ago. The only thing that matters is what the right price is today .     History is continually repudiated. For instance, through 1996, the stock market had never posted gains above 20 percent for more than two years in a row. But, through 1998, it posted such gains for four years in a row. Until recently, the average dividend yield for a stock in the Standard & Poor's 500-stock index, a proxy for the market, had never been as low as 1.5 percent. Now, it's lower. Wall Street traditionalists will tell you that the market's sharp rise is an anomaly and that P/Es of 25 and more can't be sustained. But, so far, they have been.     Sometimes, historical trends change for good, even in finance. Mainly through the research and proselytizing of investment banker Michael Milken, investors learned in the early 1980s that "junk bonds"--debt issued by corporations that lacked top credit ratings--were nowhere near as risky as they had previously thought. The spread that is, the difference in interest rates--between junk and Treasury bonds narrowed significantly and, except for brief periods, stayed there. Even more striking was the change that occurred in the late 1950s, when, suddenly, the dividend yields on stocks dipped below the interest rates on long-term Treasury bonds.     For decades, investors had demanded high dividends to compensate them for the risk of buying stocks. Why? One argument was that if a company goes bankrupt, stockholders by law stand in line behind bondholders when the failed company's assets are distributed. That sounds absurd when you consider that the companies involved are the thirty behemoths that make up the Dow Jones industrial average.     Still, in the 1950s, it was the conventional wisdom on Wall Street that investors should sell stocks when dividends dipped below Treasury bond rates--since shares were obviously too expensive and risky. But in 1959, stock yields fell below bond yields and stayed there. Recounting this episode forty years later in discussing our Wall Street Journal article, Wien wrote: This time the models didn't seem to be working. Stocks kept going higher, and the gap between the current returns for stocks widened. Equities rose 60% in real terms in the ten years after 1958. During that period, some of [the] strategists turned even more bearish.... What these forecasters failed to recognize was that investors had begun to appreciate the growth characteristics of equities, compared with the fixed returns on bonds.     Investors came to realize, almost in a blinding flash, that stocks weren't as risky as they had thought and that a dividend that grew as profits grew was far better than a static yearly payout from a bond. As a result, investors didn't need the enticement of high dividends to get them to buy stocks. This new realization caused investors to bid up stock prices sharply in the late 1950s--to a permanent new level. For example, from 1940 to 1957, the average P/E ratio never exceeded 15 in a single year. Since then, it has exceeded 15 in a majority of years.     In the 1980s and 1990s, a similar process of rethinking began again as investors started to look at stocks through a different lens. The process will continue, and as it does, the old view of valuations, based on a specific historical vantage point, will come to be rejected.     When observers say that "history" dictates certain results, they really mean a particular perspective on history. Karl Marx, for example, viewed history as class struggle, picking and choosing events and nations to make his case. The same with stocks. By focusing on such indicators as P/Es, dividend yields, and price-to-book ratios (the relationship between what investors pay for a share of a company and its net worth on the balance sheet), the current generation of observers sees only part of the picture--and it is badly distorted, as the soaring market of the past several years has confirmed. HOW WE VALUE STOCKS Turn from history to the here and now. Say that you own shares of IBM trading at $150 each. You want to know, simply, whether $150 is high or low. Should you buy, sell, or hold?     The financial expert today looks at historical valuation measures. For example, how does IBM's price-to-earnings ratio compare with the past P/Es of IBM, or with those of similar companies and the market as a whole?     But this crude instrument is meaningless if stocks have perennially been undervalued, as we believe they have. Instead, we look at what investors really want out of a stock or any other investment: a flow of cash into their pockets.     Whether IBM's price was $100 or $200 last week is irrelevant. The real question is this: Going forward , how much money will you earn by owning IBM? And how does that amount compare with what you could earn from an equivalent investment?     Some estimating is required, but not so much as you might think. And the math is fairly easy. After you have determined what IBM will pay you today and how that amount should grow over time, you can come up with a price that a perfectly reasonable person would pay right now for the stock.     What our research shows is that such prices--the PRPs--are far, far higher than prices that currently prevail. Stocks, in other words, are cheap.     Will they stay that way? Not forever. In recent years, investors have come to understand that stocks are a better deal--more profitable and less risky--than they had previously thought. In this judgment, they are far ahead of the Wall Street experts. As a result, we believe, stock prices will rise sharply as demand from more knowledgeable investors increases. Then, at some point, the returns of stocks will trail off.     When that happens (and we will tell you how to identify the point it does), the returns of stocks and similar investments will be roughly interchangeable. It won't much matter whether you buy a stock or a bond. The determining factor will be your personal needs, just as today, top-rated municipal bonds and Treasury bonds return about the same after taxes; whether you buy one or the other depends mainly on your own tax situation.     Stocks should be priced two to four times higher--today. But it is impossible to predict how long it will take for the market to recognize that Dow 36,000 is perfectly reasonable. It could take ten years or ten weeks. Our own guess is somewhere between three and five years, which means that returns will continue to average about 25 percent per year.     But the amount of time it takes for the Dow to hit 36,000 is not crucial. What's important is to understand that stocks are significantly undervalued today and that the run-up since 1982 is part of a process of moving toward more rational prices. That process is far from complete--and you can benefit handsomely as it unfolds. In the meantime, you can hold a diversified portfolio of stocks in comfort, knowing that for a solid company with good earnings growth, a P/E below 100 is not a cause for concern. PARADIGM SHIFT In 1962, Thomas Kuhn, a professor of linguistics and philosophy at the Massachusetts Institute of Technology, published an influential book called The Structure of Scientific Revolutions . Kuhn argued that in sectors of science a paradigm--a way of looking at the world, based on historical information--comes to dominate and then is replaced, swiftly and completely, by a new paradigm.     When does this shift occur? "Sometimes," he wrote, "a normal problem, one that ought to be solvable by known rules and procedures, resists the reiterated onslaught of the ablest members of the group within whose competence it falls.... Normal science repeatedly goes astray." Eventually, "the profession can no longer evade anomalies that subvert the existing tradition."     One example Kuhn uses is astronomy. The Ptolemaic paradigm, which had the earth at the center of the universe, gave way to the Copernican, with the earth revolving around the sun, when it became clear that because of the accumulation of new observations, Ptolemy's model could not provide accurate predictions of the movements of stars and planets.     The new paradigm was founded on the same initial set of facts as the old--the same basic information about the positions of the planets, for example--but it was able to incorporate new facts that the old paradigm could not.     No area of inquiry is more ripe for a paradigm shift than modern finance. The old model, which focuses on historical valuations, does not seem to work any longer. Everyday investors, spurred on by the efforts of creative thinkers like Tom and David Gardner, the brothers who launched the Motley Fool website and books, are learning to ignore the experts. Ridiculed for acting like tulip-maniacs, these small investors have acted more intelligently than the professionals and, by doing so, have profited. For example, when the Dow fell 554 points on October 27, 1997, the pros saw the decline as confirmation of their warnings about an imminent bear market and rushed to sell. Bur not small investors. Many bought stocks at what turned out to be bargain prices.     "I'm kind of floored," said David Castellani, senior vice president for 401(k) retirement plans at Cigna in Hartford, on the day after the big drop. Fully 40 percent of the callers were asking to move money from fixed-income funds into stock funds. "In the past," he said, "90 percent of the calls would have been, `Get me out of stocks!' I'd like to think that a lot of the education--both written and in seminars--is taking hold."     That education teaches that stocks are the place for long-term investments, through thick and thin, since stocks not only return more than bonds but, over long periods, are no more risky. But the new financial paradigm continues to be resisted by the establishment--and no wonder. As Kuhn wrote, "[The] emergence of new theories is generally preceded by a period of pronounced professional insecurity. As one might expect, that insecurity is generated by the persistent failure of the puzzles of normal science to come out as they should. Failure of existing rules is the prelude to a search for new ones."     Failure? Yes. Not only have financial pundits warned inaccurately of apocalypse in recent years but, worse, money managers devoted to the old model have been unable to beat simple, unmanaged index mutual funds. A majority of human-managed funds failed to beat the S&P 500 in every year from 1994 to 1998. In that last year, the portfolios of 86 percent of managers produced returns lower than the popular averages.     In the years ahead, a new paradigm will at last be accepted by financial professionals--after the public has already stumbled on it. Historian Herbert Butterfield calls this reorientation "picking up the other end of the stick," a process that involves "handling the same bundle of data as before, but placing them in a new system of relations with one another by giving them a different framework."     Is such a reorientation--really, a revolution--a certainty? No, but we believe the weight of the evidence, which we will present in the chapters that follow, is overwhelming. We ourselves have acted on it, reorienting our own investment strategies, with pleasing results, both in profits and in peace of mind.     As investors digest the evidence about stocks, they will start to understand the new paradigm intuitively--again, more quickly than the professionals. For example, the economists who discovered that stocks were no more risky than bonds did not take the next logical step: If stocks and bonds are equally risky, then they should provide roughly the same cash flow to investors, so let's figure out what a stock should return today to be the equivalent of a bond returning, say, 5.5 percent.     In Chapter 4, we work out the answer, but here's a hint: Because a stock's earnings and dividends grow, it doesn't need to return very much at the time you buy it in order to match a bond over the long run. Or to put it another way, our calculations show that the stock dividend yield that is equivalent to a 5.5 percent interest rate may be as little as one-half of one percent.     Could it be that investors are finally recognizing that stocks and bonds are equally risky and are--quite rationally--bidding up the prices of stocks to levels which make much more sense? Are everyday Americans connecting the dots and creating a new map of the financial world ahead of the experts who have so much invested in the old way of looking at things? We think so and believe that you will too after reading this book. THE NEW INVESTOR One reason that stock ownership is soaring--from 10 percent of adults in 1965 to 21 percent in 1990 to 43 percent in 1997 to an estimated 50 percent today--is that Americans have begun to understand that equities offer both high returns and, over the long term, low risk.     Another reason is that with low-cost mutual funds and tax-advantaged retirement accounts, it has never been easier to invest. In 1980, just 6 million families owned mutual funds; by 1998, that figure had jumped to 44 million, or two out of five households. From 1980 to 1998, assets held in stock mutual funds have increased from $44 million to $3 trillion. The average fund-holding family has $98,000 socked away in stocks, bonds, and money market funds. Meanwhile, 401(k) retirement plans are also booming. More than 25 million Americans participate, and total assets top $1.4 trillion.     But, with all this money sunk into mysterious equities--which, to many investors, are simply names and numbers on the stock pages--no wonder Americans are worried. This book should allay the fears. Armed with the knowledge of what your stocks are really worth, you can resist the daily drumbeat of news reporting that previously would shake your faith in what you own.     The press and the financial analysts are continually saying that stocks are overvalued, and they have continually been wrong. By contrast, Warren Buffett, chairman of Berkshire Hathaway, Inc., and the most successful investor of the past century, told investors at his company's 1998 annual meeting in Omaha: "The market is not overvalued, in our view, if two conditions are met: namely, number one, that interest rates stay at or near present levels or go lower and, number two, that corporate profitability stays close to current levels."     We concur, but take a slightly more optimistic view. Profit growth can revert to historical levels and interest rates can actually rise--as long as real (or after-inflation) rates stay roughly where they are. In that case, stocks are not overvalued. In fact, they are significantly undervalued . In the pages ahead, you will hear our argument, which goes like this:     1. Over the long term, a diversified portfolio of stocks is no more risky, in real terms, than an investment in bonds issued by the United States Treasury.     2. Stocks have historically paid shareholders a large premium--about seven percentage points more than bonds. (In other countries, the premium has been only slightly smaller. In Britain, for example, writes Martin Wolf of the Financial Times , it has been about six percentage points since 1918.)     3. This equity premium, based on the erroneous assumption that the market is so risky that anyone who invests in it should get higher returns as compensation, gives investors a delightful unearned dividend.     4. Evidence abounds that investors are catching on, realizing that the equity premium is unnecessary. So they are bidding up the price of stocks to take advantage of this terrific deal.     5. If there is no risk premium, then, over time, stocks and bonds should put about the same amount of money into the pockets of the people who buy them.     6. Therefore, the correct valuation for stocks--the perfectly reasonable price--is one that equalizes the total flow of cash from stocks and bonds in the long run.     7. Several complementary approaches show that the P/E that would equalize cash flows is about 100.     8. The Dow Jones industrial average was at 9000 when we began writing this book, and its P/E was about 25. So, in order for stocks to be correctly priced, the Dow should rise by a factor of four--to 36,000.     9. The Dow should rise to 36,000 immediately, but to be realistic, we believe the rise will take some time, perhaps three to five years.     10. In the meantime, as we show in the second part of the book, you can profit by taking our approach to your investment planning and your stock portfolio.     In other words, stocks are an exceptional investment. They are just as risky as bonds over long periods of time, and their returns--at least for now--are much higher. THE CHAPTERS AHEAD Our book is divided into two parts.     The first brings the reader through the theory--why stocks are significantly undervalued. Simple, real-world examples lead to the conclusion that a fourfold market increase--Dow 36,000--is not a pipe dream, but rather the logical consequence of careful analysis. We also provide the arguments on the other side, so that readers can judge for themselves and be armed to ask the right questions.     We begin by looking at the history of stocks and why they have risen so much lately. Then in Chapter 3, we show how to value shares in a company. In Chapter 4, we look in a cautious way at how high the market can go. In Chapter 5, we take a more reasonable--and aggressive--approach to growth. Chapter 6 presents our views on risk: why stocks are not as dangerous as they seem. The next two chapters examine the real-life market and confront challenges to our theory.     The second part of the book lays out, in detail, the investing strategies you need to adopt now in order to profit from the new financial paradigm. It also serves as a primer for both novice and seasoned investors. We tell you how to find the best stocks and mutual funds; how to allocate your assets among stocks, bonds, and cash; and how to develop the kind of personal relationship with your holdings that will produce success.     A colleague of ours, a seasoned economist, laughed when he heard the title of this book. "As long as you don't say when , I suppose it is all right," he added. But we aren't laughing. The case is compelling that 36,000 is a fair value for the Dow today . And stocks should rise to such heights very quickly. As you read on, you will realize why--and learn to invest in ways that take advantage of a remarkable time in financial history. Copyright (c) 1999 James K. Glassman and Kevin A. Hassett. All rights reserved.

Table of Contents

Prefacep. vii
Part I The Idea
Chapter 1 Introduction: Why Stocks Are Such a Good Buyp. 3
Chapter 2 The History of Stocks: A New Interpretationp. 20
Chapter 3 Dividend and Conquerp. 38
Chapter 4 A Conservative Look at How High the Stock Market Can Gop. 56
Chapter 5 A More Reasonable Look at How High the Market Can Gop. 74
Chapter 6 Unrisky Businessp. 91
Chapter 7 The Jungle Stocks Live Inp. 108
Chapter 8 Today, When Stocks Were Still Cheapp. 126
Part II In Practice
Chapter 9 How to Profit from the Dow 36,000 Theoryp. 143
Chapter 10 How to Build a Winning Relationship with Your Stocksp. 151
Chapter 11 Making Sense of Mutual Fundsp. 162
Chapter 12 Getting Started in Stocksp. 196
Chapter 13 Which Stocks Should You Buy?p. 215
Chapter 14 Stocks, Bonds, or Cash? How to Allocate Your Assetsp. 239
Chapter 15 The Wealth Explosionp. 257
Glossaryp. 269
Notesp. 275
Indexp. 287