Stocks for the Not-so-long Run

I am a fan of Jeremy Siegel's book Stocks for the Long Run. However, an article in the Wall Street Journal suggests that some of the data in the book may not be completely reliable:

There is just one problem with tracing stock performance all the way back to 1802: It isn't really valid.

Prof. Siegel based his early numbers on data first gathered decades ago by two economists, Walter Buckingham Smith and Arthur Harrison Cole. For the years 1802 through 1820, Profs. Smith and Cole collected prices on three dozen banking, insurance, transportation and other stocks -- but ended up including only seven, all banks, in their stock-market index. Through 1845, they tracked 19 insurance stocks, but rejected 95% of them, adding only one to their index. For 1834 onward, they added a maximum of 27 railroad stocks.

To be a good measure of stock returns, an index should be comprehensive (by including many stocks) and representative (by including the stocks commonly held by investors). The Smith and Cole indexes are neither, as the professors signaled in their 1935 book, "Fluctuations in American Business." They cherry-picked their indexes by throwing out any stock that didn't survive for the whole period, whose share prices were too hard to find or whose returns seemed "inflexible," "erratic," or "non-typical."

The database of early U.S. securities at EH.net has so far identified more than 1,000 stocks that were listed on 10 different exchanges -- including Charleston, S.C., New Orleans, and Norfolk, Va. -- between 1790 and 1860. Thus the indexes relied on by Prof. Siegel exclude 97% of all the stocks that existed in the earliest years of the U.S. market, and include only the bluest of the blue-chip survivors. Never mind all of the canals, wooden turnpikes, rubber-hat companies and the other doomed stocks that investors lost millions on -- and whose returns may never be reconstructed.