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Nifty Fifty: The boom in "fancy" stocks

As with many investment trends, historical backgrounds promoted the emergence of the boom around the so-called nifty fifty. As a result of the Vietnam War, the high national debt of the USA caused great concern among investors in the mid / late 1960s. Many therefore feared inflation and therefore focused on investments that promised to secure purchasing power.

Government bonds, on the other hand, were viewed with skepticism by investors because of the debt issue; although the absolute returns here were around five percent. Gold was not an alternative because private ownership was banned in the USA until December 1974.

At the time, however, investors were open to the stock market. In search of asset protection and positive real returns, many believed that they would find worthwhile investments here. In order to combine security and return as well as possible, over time more and more investors have relied on the shares of large companies with a dominant position in the market, which also have high growth rates. These included titles like Coca-Cola, IBM, Johnson & Johnson, McDonald's and Walt Disney.

The list of nifty-fifty stocks popular at the time differs depending on the source. But there is a match of 24 titles (see table below).

Nifty Fifty: Beware of confusion!

The term Nifty Fifty should not be confused with today's Indian leading index NIFTY 50.

One decision stocks

The Nifty Fifty were well-established companies in their industry. They had strong balance sheets, high profits and attractive growth rates. In addition, they had often increased their dividends since the end of World War II. With this in mind, these titles were also called "One Decision Stocks": buy once and never sell.

In fact, many analysts believed that the outlook for these stocks was so good that prices could only rise. The credo that kept the trend going: the price level is practically irrelevant because the high growth sooner or later justifies any valuation. This consensus was so decisive that even defensive fund managers found it difficult to justify themselves if they were not (no longer) invested in these stocks.

A bubble appears - and bursts

The nifty-fifty stocks became increasingly popular. The once fundamentally justified investment trend of the 1960s developed into exuberant euphoria: At the high of the bull market in December 1972, the average price / earnings ratio (P / E) of the Nifty Fifty reached a value of 41.9 according to data from Jeremy Siegel. A comparison of the valuation with the P / E ratio of the market-wide S&P 500 of 18.9 shows: The Nifty Fifty had reached unimagined heights.

The following source also suggests that the focus on these stocks could be dangerous: Author Andrew Tobias reports in his book "The Only Investment Guide You'll Ever Need" of a conversation he had with a high-ranking bank manager at the time: “[He ] told me that it was a policy of his bank to only invest in companies whose expected earnings growth is above average. What about all the other companies? No, he said, stocks in such companies are not bought. Regardless of the price? Yes, regardless of the price. "

In 1973/74, however, the bear market began. Large parts of the price gains were wiped out. The belief that growth stocks could continue their above-average earnings growth nearly indefinitely seemed to be extinguished. The events surrounding the Nifty Fifty were later reinterpreted as a valuation bubble - as an example of what end speculation based on exaggerated optimism can have.

Further performance: very different in individual cases

But how did the companies go from here? Jeff Fesenmaier and Gary Smith show in their study "The Nifty-Fifty Re-Revisited" that these later developed very differently. Some stocks surpassed even the highest expectations of the 1972 boom. Others disappointed, two companies even went bankrupt.

The retailer Walmart was able to surprise positively. The company's stock achieved an annual return of almost 27 percent for the 29 years up to 2001. On the other hand, investors were disappointed by IBM, the largest US company in terms of market capitalization for many years. During this time it fared significantly worse than the overall market. However, Polaroid's stock fell the lowest. Valued at more than 90 times the P / E ratio during boom times, the company went bankrupt in 2001.

In retrospect, less extreme

Jeremy Siegel came to a surprising conclusion in his 1998 paper Valuing Growth Stocks: Revisiting the Nifty Fifty. Even at the height of the bull market in the early 1970s, the Nifty Fifty, in retrospect, were almost worth their price. According to his calculations, the 50 stocks achieved an average annual return of 12.2 percent from December 1972 to August 1998 (S&P 500: 12.7 percent). Accordingly, the high growth expectations would have largely been met, while stocks such as Philip Morris, Coca-Cola or Merck would have been undervalued at the time.

If you follow their development over decades, growth stocks can be worth their high price - but not at any price: According to Siegel, the 25 highest-rated stocks as of 1972 achieved only about half the return of the 25 lowest-rated stocks by 1998. The judgment in the study by Fesenmeier and Smith is similar. The authors use a different composition for the Nifty Fifty with a higher median stock valuation. Your result: a ten point higher P / E ratio goes hand in hand with a two percent lower return.

This research shows that investors would have done well with the "value stocks" among the Nifty Fifty in particular. However, those who only bought after the crash benefited most in the mid to late 1970s: At this point in time, these stocks were valued far lower than they were in 1972 and were able to clearly outperform the overall market in the following decades.

Conclusions

If we look back at the developments surrounding the Nifty Fifty, we see that a great company does not have to be a great equity investment at all times. Rather, it is the assessment that is decisive. According to the studies mentioned, moderately overvalued stocks can definitely outperform the market; but the highest-rated stocks are more likely to buy into exaggerated growth expectations that are later disappointed.

The fears of high inflation, which contributed to the trend towards the nifty fifty, were only confirmed after the boom. In retrospect, this is also revealing: Expectations can be a driving force in the markets and support investment trends even if they do not materialize in a timely manner.

Photo in header © Robert Knapp, Alamy.

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