“... our job is to help you be greedy when others are frightened, and cautious when others are greedy... Correction can be a scary experience... How should we react? Mostly by doing nothing."
- Peter Lynch, legendary investor (One Up on Wall Street)
None of us wanted to think about global economics this holiday season! But markets gave us lumps of coal in our stockings, so we haven’t had much choice.
Here’s my attempt at the ultimate holiday gift: Some peace of mind through. . .
If you own stocks, remember that you are an owner of a collection of real businesses. That means that you own an earnings stream from these businesses.
Over time, the earnings stream for your businesses should grow at a rate in line with the economy.* Thus, if you believe that people will continue producing and consuming, innovating and inventing, buying and selling, then you should have confidence that your earnings stream will grow over time.
It is hard to be a pessimist on humanity if you've used an iPhone … or taken an Uber … or eaten an Impossible Burger. Improving livelihoods tends to correlate with growing economies.
Approximately 35% of your companies’ earnings stream is paid out in the form of dividends, while the rest of the earnings are retained inside your companies. Historically, these retained earnings have earned over 10% returns on equity. (Global companies have a return on equity of over 13%.)**
The good thing about lower stock prices is that you can buy additional shares of your companies at lower prices (thereby increasing your earnings stream). Based on today’s prices, shares acquired today have an Earnings Yield of approximately 7%.***
But there’s a catch . . .
Or more precisely, there’s a cost: volatility and uncertainty. There’s volatility in the price “the market” will pay for your companies’ earnings streams. It is thus uncertain what the liquidation value of your portfolio is on any given day. That is the price we pay in exchange for the higher long-term return potential of owning stock in companies.
For every $1 of your earnings stream, the market is willing to pay approximately $15. But "Mr. Market" is manic. Tomorrow he might be depressed and offer only $10 for your earnings. Another day down the road, Mr. Market might pay $20 or higher. Good luck trying to predict his moods. Warren Buffett argues that's a fool's path.
Truly long-term investors are not vulnerable to stock price swings because they do not plan to sell their companies. They recognize that stock is a claim on an earnings stream. Thus, all they care about is (at some point) living off of this earnings stream (in the form of dividends that are paid out of it – typically ~35% of earnings).
Another's Curse, Your Blessing
If anything, lower near-term stock prices are a benefit to long-term investors, since it lets them buy more earnings at a lower price. For those still in the accumulation phase, lower prices are a blessing.
Again, if your goal is to create a sustainable passive income stream that is immune to inflation long-term, owning a collection of businesses is your best choice. Historically that’s been the case, and I believe, it will remain the case for millennia to come. Publicly traded stocks are the cheapest, most efficient way for investors to do that. Whoever is in the White House. Whatever the crisis du jour may be.
What really matters for your long-term financial well-being is accumulating an earnings stream.You want to acquire these earnings as cheaply as possible. Lower stock prices are thus a gift, not a lump of coal.
Your Own Earnings Stream?
How much stock must you accumulate to fund an adequate and sustainable retirement income? Reply to this email if you’d like to receive a simple spreadsheet I’ve designed to help you calculate this. All you have to say is “Spreadsheet!”.
Happy Holidays from all of us at Fielder!
Frank Byrd, CFA
*Presuming you have a broadly diversified portfolio in line with broad market indices.
**When discussing this hypothetical earnings stream throughout this note, I am referring to broad market averages. I use the Vanguard Total World Stock ETF (VT) as a proxy for the global stock market. Any reference to “your earnings stream” is not to be taken literally. This note is shared with a large number of readers and is for educational purposes only. Nothing described herein refers to any specific investor or client. Thus, you should not rely on these statistics as descriptive of your specific situation. This note is for educational purposes only and uses broad stock market indices as proxies for hypothetical group of companies described herein.
***Earnings Yield is calculated by the ratio of earnings per share to price (or E/P, the reciprocal of P/E).
Disclaimer: While the information presented herein is believed to be accurate, Fielder Capital Group LLC (Fielder) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in the document. Fielder is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Nothing herein should be construed as a recommendation to buy or sell any of these securities. It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Fielder makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Fielder or its employees may have an economic interest in securities mentioned herein.