We started researching this essay to highlight the similarities between 1968 and 2016. Major topics in 1968 echoed in 2016 were Black Power, Women’s Liberation, Gay Rights, and antiwar movements. There was a presidential candidate who opposed changes to the status quo, George Wallace, with the moniker “Law and Order”. Riots seemed possible at campaign stops for Wallace and Humphrey. Nixon had a secret plan to end Vietnam, but would not tip off the enemy by sharing it. The Dow Jones Industrial Average (the Dow) had a correction in the first quarter, but recovered to end the year with a total return of approximately 7%. Since then the Dow has gone from around 900 to over 18,000 today. Then something held our attention when looking at the S&P 500 compared to the Dow.
A little background on the Dow and S&P 500 Indexes
The construction methodologies for these indexes are quite different. The Dow does not include transportation or utility companies and simply states, “a stock typically is added to the index only if the company has an excellent reputation, demonstrates sustained growth and is of interest to a large number of investors.” The S&P 500 has multiple technical inclusion criteria relating to size, liquidity, public float, and GICS sector; but it primarily seeks to include “leading companies in leading industries”.
The indexes levels are calculated in very different ways. The Dow is price weighted and higher priced stocks have a larger impact than lower priced stocks. By contrast the S&P 500 is market cap weighted so that larger companies have a larger impact than smaller companies. It is as if the folks at Dow Jones chose the laziest method while the folks at S&P welcomed the extra labor and sophisticated calculations required to produce an index that thoughtfully represented the general economy.
Off the cuff, when we think of the Dow we think of them waiting until 1997 to add Wal-Mart and 2015 to add Apple, even though each stock had already risen over 15,000%. We think of Microsoft and Intel being added near the top of the tech bubble in October 1999. And off the cuff, when we think of the S&P 500, we think of the reputation for including companies in cutting edge industries that become homeruns, such as Amazon and Google. The Dow is unimaginative, very late to recognize changes in the economy, and often goes years without making a change to a list of 30 stodgy constituents. The S&P 500 seems relatively savvy, and is widely touted as a benchmark that is very tough to beat.
The Important and Instructive Observation
When RAM was in its early years, we noticed that the level of the Dow was usually a little less than 10x the level of the S&P 500. What caught our eye and floored us in researching 1968, was that the ratio in the levels was pretty much the same back then. It is important and instructive to RAM that the levels of the Dow Jones and S&P have retained the roughly 9:1 ratio in terms of price levels. For some years the ratio was smaller, as the S&P 500 increased faster than the Dow. For example, in the 1990s, technology stocks pushed the S&P 500 up at a faster rate and in January the ratio shrank to less than 8 (in 2000 the Dow was in 11,000s while the S&P 500 was in 1,400s). But by December 2002 the ratio had reverted to 9.3 (8341 for the Dow and 900 for S&P). As recently as April of 2013, the ratio was the same 9.4 as it was around the beginning of 1968. Furthermore, considering that the dividend yield of the Dow has been greater than the dividend yield of the S&P 500, the Dow has outperformed the S&P 500 on a total return basis since 1968. This begs the question, how could these large companies with household names possibly keep pace with the dynamism of the S&P 500 that is so highly touted today?
From RAM’s point of view, the answer is that most of the returns experienced by investors over the long run result from owning well run companies for long periods of time. And while it is easy to recall an array of examples of homerun stocks in the S&P 500; apathy impedes awareness of the far greater number of companies that withered.
RAM has four main all cap strategies (Core Growth, Conservative Growth, Growth at a Reasonable Price, and Equity Income). All strategies seek to hold shares of solid companies for long periods of time, and that is why it would not surprise us if the strategies had similar multi-decade returns.
The index comparisons that did not surprise us involved relating small cap indexes to the S&P 500. Historically, small caps have simply done better by a margin that is attractive to us, though with greater fluctuations. Hence RAM’s Small Cap and Concentrated strategies have a fair chance to do a bit better than our four main all cap strategies.