Michael Mauboussin: "Why Doing Less Can Actually Make You More"

MICHAEL MAUBOUSSIN: Right. I would just say for most investors, if they're not inclined to spend a lot of time to try to figure out who the successful managers are, index funds are a great way to go. I’ve always believed that. They're low cost. They give you exposure to markets in a proper way. So the answer would be for many people, that is the right solution. However, if you want to generate excess returns, you really do have to look at active managers. And if you really want to do your homework, that would be sort of a checklist or a set of templates to look at to try to do that. So for most people, if you're not inclined, index it. If you are inclined, you want to go for excess returns, use that as a template to try to assess who is going to do a good job for you and who is not.

CONSUELO MACK: So Michael, another thing that you’ve written about which is so interesting and really shatters a myth that most of us have, and that is the fact that we know statistically that dividends have contributed a great deal to stock returns- 40% percent plus over the last 200 years. But you are saying that dividends in fact, if you look at the real role that dividends have played in investment returns, it is not as great, and that you should really take a look at that. So what is the real role that dividends have played in our investment returns over the years?

MICHAEL MAUBOUSSIN: So there are a couple of really crucial issues here. The first one is that when people talk about returns for an asset or a stock, they often talk about total shareholder returns. And just to explain what that means, it means if you have a stock that pays a dividend, that you are taking 100% of that dividend and reinvesting it back in the stock over time. So it turns out in the real world, very few people actually do that. And it’s also that assumption ignores taxes. It doesn’t assume you pay any taxes. So in the Financial Advisor, for example, it says the total share of the return the S&P 500 has been some number. You have to acknowledge that that includes reinvestment of 100% of the dividends with no taxes. So that’s the first thing just to be mindful of.

The second thing is, of course, if you think about it, what matters to you as an investor is your capital accumulation rate. How fast your dollar will grow over time. When you're reinvesting, it’s a key thing to realize is it’s not something extra. In other words, if you have a $100 stock and it pays a $3 dividend, what happens is one day you're going to have a $97 stock and a three dollar dividend. Right? So if you reinvest it, you’ll be back to $100. So price appreciation is the only thing that shapes the capital accumulation rate. That’s the key idea. Price appreciation is the only thing that affects your capital accumulation rate.

CONSUELO MACK: So what’s interesting to me about that is that we have been told to look at the total return, and we’ve also been told that cash in the hand is better than two dollars in the bush or whatever. So in fact, if we really want to focus on what the capital accumulation is from price appreciation, does that mean that we should look at different types of stocks?

MICHAEL MAUBOUSSIN: Right. And it turns out, there’s nothing wrong with different kinds. I want to be clear about that.

CONSUELO MACK: Right.

MICHAEL MAUBOUSSIN: And in fact, we know that over long periods of time, dividend paying stocks have actually done quite well. They grow their earnings at very satisfactory rates and they’ve done quite well. So there’s nothing wrong with it. It’s just to be very clear that that argument only works if you reinvest 100% of your dividends in an unencumbered fashion. So studies of what people actually do, most of us take that dividend and we go off and do something else with it. We either spend it, we consume it, or we use it to buy some other asset class. So the key is that those total share of returns can be very, very misleading.

CONSUELO MACK: So as a value investor, you think that there is actually tremendous value to be found in the stock market right now. What’s so attractive about the stock market?

MICHAEL MAUBOUSSIN: Well, if you just take one step back, the key is, as we talked about before, is valuation. And you want to own things in an attractive valuation. And when you look at the S&P 500, for example, largest index, it depends what numbers you use, consensus for 2011 or 2012. But we're probably under 13 times based on 2012 estimates.

CONSUELO MACK: Price earnings multiple?

MICHAEL MAUBOUSSIN: Price earnings multiple. Correct.

CONSUELO MACK: And historically, that’s where?

MICHAEL MAUBOUSSIN: Historically, it’s been quite a bit higher than that, in the mid teens, call it 15 or 16. But the key thing to consider in that is also interest rates. Right? And particularly, risk free rates. So the ten year treasury note yield today is around three percent. So there are now forecasts that the excess return for owning stocks over the risk free rate is about 5.3%

CONSUELO MACK: So that’s assuming a return on stocks of like 8.3%.

MICHAEL MAUBOUSSIN: 8.3%. So the relative attractiveness of U.S. equities versus our government fixed sum markets are really, really good today.

CONSUELO MACK: What about the fact that the Federal Reserve has been buying ten year treasuries up until now? And in fact, so couldn’t that be an artificially low risk free return at three percent in the ten year treasury?