How the S&P 500 destroyed $4.5 trillion

By Felix Salmon
February 18, 2011

At the end of 1993, Cisco Systems had a market capitalization of $8 billion. At the end of 2010, it was worth $112 billion. It hasn’t paid dividends, which makes things easy: if you want to calculate the amount of shareholder value that Cisco created between 1993 and 2010, you just subtract the former figure from the latter and get an impressive $104 billion. Right? Wrong. In fact, if you go through the history of Cisco’s stock actions year by year, it turns out that the company has managed to destroy $105 billion over the past 18 years. Microsoft and Intel have both destroyed $72 billion, Time Warner managed to destroy $130 billion, and Pfizer destroyed a whopping $188 billion. Four of the top five value destroyers, however, were financial: AIG, GE, BofA and Citigroup between them destroyed a mind-boggling $739 billion between 1993 and 2010, most of it in 2008.

All these numbers come from my new favorite paper, the product of some serious number-crunching at IESE Business School in Madrid. (Update: I missed some small print in the methodology, so while this paper is interesting it’s not quite as interesting as I thought at first. See below.)

Here’s the abstract:

In the period 1991-2010, the S&P 500 destroyed value for the shareholders ($4.5 trillion). In 1991-1999 it created value ($5.1 trillion), but in 2000-2010 it destroyed $9.6 trillion. The market value of the S&P 500 was $2.8 trillion in 1991 and $11.4 trillion in 2010.

We also calculate the created shareholder value of the 500 companies during the 18-year period 1993- 2010. The top shareholder value creators in that period have been Apple ($212bn), Exxon Mobil (86), IBM (78), Altria Group (70) and Chevron (67). The top shareholder value destroyers in that period have been American Intl Group ($-217), Pfizer (-188), General Electric (-183), Bank of America (-170), Citigroup (-169) and Time Warner (-130). 41% of the companies included in the S&P 500 in 2004 or 2010 created value in 1993-2010 for their shareholders, while 59% destroyed value.

How can the S&P 500 destroy $4.5 trillion of shareholder value over a period when its capitalization rose by $8.6 trillion? The answer is that companies issue stock when it’s expensive, rather than when it’s cheap. During the dot-com bubble, Cisco was an M&A monster, going on a massive acquisition spree and nearly always paying in its highly-rated stock. When that stock crashed, it took down with it all the value invested at the top of the bubble, which was many more shares than were oustanding back in 1993. More generally, companies with high-flying stocks are likely to pay their employees with stock or options. That can account for a lot of value destruction if and when the shares fall to earth.

That said, the S&P 500 would have created shareholder value, on a net basis, between 1991 and 2010 were it not for the annus horribilis of 2008, when $5.8 trillion of value was destroyed. In general, the down years are much bigger than the up years: the best year of all was 2003, when $1.7 trillion of value was created, while substantially more than that was destroyed in each of 2000, 2001, 2002, and of course 2008.

This is one of the main reasons why the returns that real individual investors get from investing in stocks are substantially lower than the theoretical numbers that financial advisers love to show you. And why you prefer to get paid in cash rather than in stock.

Finally, I think this paper demonstrates that Apple is a screaming long-term sell right now. No company, bar Apple, has even created $100 billion of shareholder value over the past 20 years, let alone the $212 billion figure that Apple is currently boasting. It’s an extreme outlier, and the downside is enormous: if you buy Apple shares now, there’s $327 billion of downside.

Google, by contrast, is much less of an outlier, having created a relatively modest $5 billion of shareholder value in its time as a public company. Go check out the number for your own favorite stock in the appendix of the paper, which lists shareholder value creation between 1993 and 2010 for all 633 companies which were part of the S&P 500 either in 2010 or in 2004. Most of the numbers — 59%, to be precise — are negative.

Update: Thanks to eagle-eyed commenters for catching something very big here: the paper is measuring risk-adjusted returns, not absolute returns. According to the definitions in the paper, “A company creates value for the shareholders when the shareholder return exceeds the required return to equity”. And the required return to equity is defined as the return of long-term treasury bonds plus a risk premium which seems to fluctuate between about 4% and 5%. Remember that long-term Treasuries did very well indeed over the period in question. So the value-destruction figures here are a bit fictitious: it’s not actual money being destroyed, but rather the hypothetical money that you would have got if you’d invested in instruments yielding about 4.3% over Treasuries. I’d love to see the numbers raw, without the risk adjustment.

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