Michael Lewis And Flash Traders Do Not Affect Long-Term Investors
One of the things that I find remarkable about investing is that, over long periods of time, the results that you experience tend to mirror the earnings per share growth rate plus dividends of the companies in which you buy business interests.
Ten years is probably the shortest amount of time that we can categorize as “long term”, so let’s take a review:
Since 2004, Colgate-Palmolive has grown earnings per share at 8.5% annually. The dividend is generally somewhere around 2%. And over the past decade, investors have received annual returns thereabouts: 11.03% annually.
In the case of Southern Company, you get about 4% earnings growth and a 5% dividend each year. And, over the past decade, investors have achieved total returns of 9.20% annually.
For Boeing, you got 10% earnings per share growth and a dividend around 2-3% annually. The total returns for investors have been just under 14% for the past decade.
For Aqua America, whose DRIP I recently discussed, you usually get about 6.5% earnings per share growth and a 3% or so dividend over the past decade. Does it come as any surprise that its performance over the past decade hovers near the 10% annual mark?
When the returns don’t match up to what you expect, it’s because of changes in the P/E valuation. Over the past ten years, Microsoft has grown by 11% annually and started paying out a dividend usually in the 3% range. Yet, investors only received 7% annual returns. Why? Because the P/E ratio fell from 25x earnings to 12-14x earnings.
The recent topic of interest among finance writers is Michael Lewis’s new book that talks about high-frequency traders and manipulation in the market. In the short term, Juvenal could write an epic poem dedicated to the “bread and circuses” style of day-to-day trading. There’s a reason why Benjamin Graham once said: “In the short run, the market is a voting machine. In the long run, the market is a weighing machine.”
On a day-to-day basis, the stock market is nothing but an auction house driven entirely by what random people with money (usually on Wall Street) want to pay for a stock. But the forces of earnings per share growth and dividends exert their own gravitational pull over time; if Coca-Cola grows its business by 8% annually over the next twenty years, and you get a 3% dividend yield, you’re going to get returns around 11%. The only way you wouldn’t is if the company’s long-term valuation changed; if investors twenty years from now are only willing to pay 15x profits for Coca-Cola stock, then you’ll do worse than 11%. If they are willing to pay 25x earnings for shares of the company, then you’ll do better than that 11%.
You can feel free to yawn when people talk about the stock market being rigged. Even on a day-to-day basis, it’s still about volitional transactions and bidding (it’s just that sometimes people transfer their wills to computers to act on their behalf). The results it produces, in the short term, can be fairly characterized as insane. Yet, once you study the business performance over long periods of time, you’ll see that the results tend to mirror the growth of the business (on a per share basis) coupled with the dividends. The only people who have to pay attention what’s in Michael Lewis’s new book are those who view businesses as something to rent and sell quickly on a highly liquid exchange. If you treat it as a facultative market that allows you to gradually build up positions in honest-to-god businesses that sell and make stuff at a profit to consumers, then you’re free to regard high-frequency traders as nothing more than characters from One Flew Over the Cuckoo’s Nest with MBA degrees.