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Tickers in this Article: CSCO, JNPR, NT, BRK.A, PG, AXP, KO
In early 2001, Warren Buffet wrote a famously circulated paragraph that explained his market-beating performance for the prior year. "I will tell you now that we have embraced the 21st century by entering such cutting-edge industries as brick, carpet, insulation and paint. Try to control your excitement". This could be the mantra for an investing strategy that, in a protracted backlash against the tech-bubble crash, embraces the notion of "seek the familiar" (especially for those unfortunate enough to lose their shirts in the price crashes of such companies as Cisco (CSCO), Juniper Networks (JNPR), and Nortel (NT)). This viewpoint advises you to buy real stuff, familiar names, known quantities, large cap names and/or strong brands. (The Buffett/Berkshire Hathaway (BRK.A) portfolio is comprised of many such names including Coke (KO), Gillette/Procter and Gamble (PG), and American Express (AXP)).

A recent post by one investment advisor in this camp highlighted the proven advantage of investing in paint, cement, plastic and lawn-care products because they have been reliable, if not exciting, performers. Essentially, these products are concrete (pardon the pun) and familiar, rather than obscure. Paint, cement and plastic are certainly useful, but before we dismiss them as "familiar," consider how these everyday products might evolve over time. For example, the paint on a car might contain tiny photovoltaic solar cells; the plastic, a material that is already beginning to replace steel in bridges, could be enforced with ultra-strong carbon nanotubes; and translucent cement may resolve a longstanding architectural trade-off between a desire for light and the need for structural solidity.

In his new book "The Future For Investors", Jeremy Siegel explains why the "tried and true will triumph over the bold and the new." His case against technology and in favor of health care, consumer staples and energy rests on a historical analysis of sectors in the S&P 500 (an unforgivably biased sample because, for many of the companies in this index, their best days of growth are behind them by the time they arrive into the index. His whole book and premise is akin to using a sample of the 50 Miss America contestants to ask the question, "Who among them is more beautiful?" Answer: at that level, it's pretty hard to find unattractive people). Siegel also argues that technology increases productivity but destroys shareholder value because it induces competition; customers benefit from lower prices, while owners do not. Siegel also says that earnings for technology firms are unpredictable. His advice, therefore, includes seeking "winning management" in losing industries like airlines, retail and steel.

Did you ever notice how easy it is to appreciate Southwest Airlines (LUV) after they had experienced demonstrable, well-publicized success? But how, exactly, do you spot winning management before it shows up in the stock? My advice is to be very careful in following Siegel's advice. It is nostalgia and nostalgia could be dangerous to your portfolio.

The notion of favoring "the familiar" that Siegel advocates is based on an extrapolation of history. However, the common academic exercise of extrapolating historical trends is a suspicious one. Just because we are stuck with a single set of historical market returns does not necessarily make them useful. It is one thing to extrapolate economics and fundamentals, which may be useful, but to extrapolate market price or returns data is suspect. Any such extrapolation based on recent data is hopelessly infected by a single overarching and unrepeatable phenomenon: the raging bull that begun in 1981. This occurrence corresponded to a long-term, secular decline - a regime change, really - in interest rates. A similar, market-wide doubling (or near-doubling) of P/E multiples spurred by this downward shift in rates cannot be replicated going forward. In other words, real interest rates probably aren't going to go to negative 3% and allow trailing P/Es to double by 40x or 50x. This much we know, at least we think we know.

But more importantly, what if Ray Kurzweil is correct, in "The Singularity is Near", when he argues that the rate of change is itself accelerating and we often confuse exponential change for linear change simply because we are too close to the current moment. His singularity refers to a convergence among information technology, biology and nanotechnology, each of which is advancing exponentially. This is a great philosophical debate that has very practical consequences for your portfolio: is change linear (and familiar) or nonlinear (and unfamiliar)?

I conducted a simple analysis to identify the sources of recent growth. My analysis does not consider market returns but rather fundamental (sales) growth. I took the sample of all publicly-traded companies in my database and pulled the companies in the top decile (top 10%) in regard to sales growth over the last five and seven years (seven years is the limit in my database). This yields about 300 companies that I will call the "fast growers." These are the fastest growers of the lot. Over the last five to seven years, these companies grew sales faster than 95% of their peers. As you would expect, shareholder returns for the group are pretty good. This is not a perfect analysis, as it does not consider companies that were acquired....

Please stay tuned next week for Part 2 and the conclusion of "The Only Sector That Matters" as David presents very compelling data! If you are interested in what we currenly hold in the three Investopedia Advisor model portfolios, try the service risk-free by clicking here.

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