Doom, Gloom and the Stock Market

My prescription: don’t read the newspapers. Or at least, read them knowing that doom sells, and “things are actually just muddling along” doesn’t shift newsprint. Also consider, if you can read a consensus opinion in the mainstream press, how many days/weeks/months ago it was absorbed into the market price.

The stock market in the short run simply reflects the sum total of what people are currently feeling. Numbers like 6000 and 13000 are meaningless without some concept of value – once upon a time the Dow approaching 1000 would have people yelling “too high”, it is all relative to value.

For me this so called Fiscal Cliff is once again a media dream come true. Anyone would believe the US and the rest of the world automatically go into recession on the 1st January if a deal isn’t done. Yes, the cuts and tax rises kick in but $600bn does not disappear overnight. As for the debt ceiling, people forget it has always historically been raised despite its use as a political football and it’s not the size of it that matters, it’s how affordable it is that counts.

I’m confident that one day, 13k will look cheap – and I’m talking about the S&P not the Dow in that instance. The S&P will have to be earning $850 per unit or so, which sounds ambitious at current $85 earnings. It sounds less absurd when you know the S&P was earning $8.50 in 1975, $0.85 in the 1940s.

Whether or not a half-random number is going to go up or down in the next week or month is very difficult to guess, you have extreme levels of competition, and I’m highly doubtful anyone can find the answer to short term movements in newspapers or common opinion about national debt, impending doom, the weather, or anything else. I’m very envious of anyone capable of that – but I’ve found they use their instincts, momentum from news/data, breakouts and technical analysis in their pursuit of those short term gains. (and the very good ones do spectacularly well, but they’re 1 in 1000 and exceptionally skilled, disciplined and experienced… which doesn’t sound like me lol)

Meanwhile, tick, tick, tick, another second passes, and TSCO make another £88, tick, tick, £88, £88, tick. In ten minutes, TSCO have made over £53k in attributable after-tax profit for shareholders, assuming profit is more or less the same as last year. That’s usually not a bad assumption either. Tick. Tick. Tick. £320k an hour, while you’re awake, or while you’re asleep. Wake up after an 8 hour sleep and it’s made another £2.5m. £7.6m a day. Tick tick tick. As a shareholder owner of a business, you know that whether you’re the smallest investor or the country, or the biggest institution, you can earn a proportion of a top company’s profits by doing absolutely nothing.

If we purchased £100k of TSCO with the price at £3 (there were some who were advocating this such as Henry), we’d have been able to purchase 33333 TSCO shares, letting us attribute about £32 a day, or £11631 a year, to our part ownership of the business. And those shares don’t expire, so long as TSCO remains in business (as few doubt it will suddenly cease to). If the company stagnates and does nothing, earning £11631 every year and doing precisely nothing with the money it retains, we are paid off within 8 years and then have a 100% free stake, earning £11631 indefinitely until the company dies.

Of course, no good business just pumps out everything it earns back to shareholders like a bank account. It hands out £13.48 per day as your dividend out of the £32, or £4919 a year, and retains the other £6711. Many investors disregard this monumentally important figure as if they don’t earn it at all. But it goes back into the business, firstly a % of it must be used to simply keep the current business afloat (repainting the buildings, updating machinery to keep up with industry standards, research spending – anything that effectively would keep the company earnings that £11631 a year). Then the rest of the £6711 of your earnings (and in a good business, this will be a high portion of that money), is spent effectively trying to improve and expand the business’ earning power. Naturally good businesses will find this fairly “easy”, their earnings record will reflect the progress over a 10-20 year period, and the return on shareholder equity will be consistent and strong.

Whether your ownership simply collects £11631 every year (the re-invested capital produces no remarkable returns), or the base improves even at a slight rate of 5% per year, is a huge difference in your returns. After 20 years, you’ll have made 70% more than in a no growth scenario (£415k total attributable earnings vs £244k). Instead of taking 8 years to pay off, the investment takes just over 6, and has made £128k total earnings by the time the no-growth version has paid off its 100k. Increase it to an assumption of 10% growth in intrinsic business value per year, and after 7 years, you’ll likely be earning almost double (£24932) the £11631 you earned in your first year, all for doing nothing, and paying zero commission to brokers, spreads or the rest. In terms of tax, you pay that on the dividend, but nothing extra on the rest – notice you’ve not paid a penny of capital gains tax either.

You’ll probably find that a version of yourself, seven years younger, is suddenly willing to pay you £200,000 (same 8 p/e) for your shares, with the same bright-eyed enthusiasm and logic as yourself. If the market is in a hopeful mood, maybe even £400k (17 p/e) for your stake. After all, the intrinsic value of the business and its earning power has doubled, and you’ll have earned £133,000 as the part owner of the business by that stage – 33% more than you even invested to begin with.

It won’t be nearly that smooth running, needless to say. There will be recessions, disasters, terrorist acts, wars, a crisis or two. And there will be times when your business becomes quite unpopular. Earnings even in a wonderful business will be far from easy to predict in the short term, but over a longer period, you can make reasonable conservative guesses. But you’d never consider selling your house because the fiscal cliff is making you nervous, or because there’s an EU Summit about Greek debt in a week’s time, or any other short term blip. Treating a business like my home, and not as some arbitrary number to bet on, does wonders to help me sleep at night. That, and the tick, tick, ticking of my Tesco Value Clock.

Tremendous profits can be realized in both an up and down market. In fact, many people, including well respected industry experts, believe that down markets provide golden investment opportunities for investors. Either way, choosing the best cheap online stock trading website to join is important in order to maximize profits. While these websites enable you to trade for a fraction of what a broker would charge, their real value is in the tools they provide the investor.

Note: I’d just be wary that a lot of people will have the same idea, there are people coming onto CNBC saying they’re “fully in cash” etc. Uncertainty can create wonderful opportunities to make longer term investments in the market.  From a real investment standpoint, whether or not the US “goes over the fiscal cliff” is not a big deal. If anyone tells you the “fiscal cliff” is the biggest factor in their investment decisions for 7-10 years, they’re being extremely optimistic about the thousands of other things (wars, terrorist attacks, earthquakes, nuclear accidents, food shortages, another financial crisis) that could crop up between now and 2020 that might cause their companies to be worth less. Of greater consequence is the solution they come up with, and how it treats shareholders and businesses in taxation terms. If it’s a lousy deal for GDP or growth, the market won’t like that either, but it shouldn’t affect long term intrinsic values especially.  Having said all that I’m still not particularly happy with US valuations (less so every day the market rises) unless earnings/GDP grow above expectations this year. Not bullish on the S&P at these levels as an investment, and in fact, wouldn’t be surprised if the S&P finished the year lower than this if business conditions don’t pick up in the States.

“Investment is most intelligent when it is most businesslike.” — Ben Graham