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Stocks:
The Long-Term Outlook
It
is widely accepted that stock prices are driven by two basic factors: company
earnings and what investors are willing to pay for those earnings.
But what are
the factors that determine earnings and investor perception? According to Warren
Buffett, one of America’s best-known investment gurus, there are three
fundamental variables to consider when assessing the outlook for stocks.1
Interest
Rates
Most
people consider interest rates only when they are buying bonds, paying
credit-card bills, or obtaining a loan. In fact, interest rates have a much
broader impact. Each change in interest rates affects the value of financial
assets. When rates are low, it may take less money to turn a future dollar of
profit than when rates are high.
Profitability
Growth
When
a company is able to extract more output per dollar spent on doing business,
growth in profitability occurs.
All the technological
improvements of the past century — electricity, automobiles, aircraft,
electronic communication — allowed American workers to be vastly more
productive. During the 20th century, per-capita U.S. output grew 702 percent,
before factoring in inflation.2
Investor
Confidence
No
matter how profitable U.S. corporations might be, stock prices are likely to go
up when investors expect rising profits. Between 1964 and 1981, a period of low
investor confidence, gross national product (GNP) grew 373 percent, yet the Dow
Jones Industrial Average grew just one-tenth of 1 percent. From 1981 to 1998,
when investors were more optimistic, GNP grew 177 percent while the Dow gained
nearly 1,000 percent.3, 4
1–3) Fortune magazine,
December 10, 2001
4) Wiesenberger, 2002. Performance shown is for the periods 12/31/1964 to
12/31/1981 and 12/31/1981 to 12/31/1998. Stocks are represented by the Dow Jones
Industrial Average, which is generally considered representative of the U.S.
stock market. The performance of an index is not indicative of the performance
of any particular investment. Individuals cannot invest directly in an index.
Past performance is no guarantee of future results.
© 2002 Emerald Publications
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