A Particular Example To Explain Why Market Timing Is Unnecessary

Imagine that, eight years ago, you had the intelligent thought: “Colgate-Palmolive is an excellent company that is worth buying anytime I can get an earnings yield of 5% or better because I like my odds when I own a company that grows profits 8-11% annually, pays out a dividend around 2.5%, and has such high profit quality that the dividend has been able to grow during every year since 1963. Plus, things like dish soap, toothbrushes and toothpaste, and household cleaning products will be around for a long time and Colgate-Palmolive owns a lot of products in those categories that people gravitate towards almost subconsciously.”

In 2007, you would have gotten a chance to own the company you desired on your terms: Colgate made $1.69 per share in profit in 2007, and would have traded at 20x earnings or below anytime that the stock price was below $33.80. Colgate traded as low as $31.90 that year, and spent a good chunk of the time over 20x earnings, but still, you would have had a moment to get your price if you were looking for it.

From 2007 to 2015, Colgate did exactly what you would have wanted. Profits moved along nicely, from $1.69 in 2007 to an estimated $3.10 in 2015. The dividend of $0.70 in 2007 continued its streak of annual growth, with the annual payout now at $1.44—Colgate is coming close to paying out as much in 2015 dividends as it generated entirely in 2007 profits. The march upward continued from anyway you might measure it—counting the dividends and the rising stock price to $70 per share that is the result of always improving fundamentals, Colgate-Palmolive has delivered 12.84% annual returns since 2007. This is the kind of company that you want to buy, and then hold for the rest of your life as the cash payments pile up year after year.

Now, let us talk about the comparison points of 2007, 2008, and 2009 specifically. During that time, Colgate did what anyone studying the business expected it to do: Sell a whole lot of Ajax, Palmolive, Irish Spring, Murphy, Soft Soap, and of course, Colgate toothpaste. Given that Colgate earns $0.25 in profit on every dollar you spend buying its goods, you’re not going to have too many down years with a company like this. The Great Recession was no exception. Profits of $1.69 in 2007 grew to $1.83 in 2008 and then grew again to $2.19 in 2009. The annual dividend payment went from $0.70 to $0.78 to $0.86.

Looking at Colgate’s performance as a business, you would have no idea that the second worst economic conditions of the past century were occurring during this period. If this were a private business that you owned in entirety, you would have gotten richer throughout the crisis, and your purchasing power may have even increased by more than you would think, given that some economic indices reported price deflation during 2008 and 2009 so that Colgate’s profit growth is even more impressive than it first appears.

But, of course, Colgate-Palmolive is not a private business. That was just a fiction I created to illustrate the point, and we live in a world where net worth can be accessed and tallied by merely looking at the price of the stock. What did Colgate do during this period? The stock climbed from $31 to $40 in 2007, and then went down to $27 in 2008, and then went up a bit before going down to $27 again in 2009.

This gives me a chance to explain why I have no interest in market timing. The math of market timing is why people become swing traders in the first place—who wouldn’t want to have $41 worth of Colgate get sold and then have all that capital get reinvested back into $27 at the low point. The problem is this: Market timing does not require that you make an accurate assessment about a business, but rather, that you making an accurate assessment about how irrational people will respond to short-term news events. To successfully market time, you would have to reach the conclusion “Colgate Palmolive will grow and raise its dividend, but because people are super worried about the large banks, the price of the stock will fall 34%.” The financial costs to you and your family of trying to market time, but then incorrectly doing so, are quite real and substantial: In the case of Colgate-Palmolive, if you sold at $40 and expected to get in at $25, you would have never had that moment, and you would have been locked out of breaking even on the stock since 2011.

Not to mention, look at what happens to someone that sticks with it: Those $800 dividend checks that got reinvested at $28 per share during the low of the recession bought you 28.5 new shares of Colgate-Palmolive. And those 28.5 shares are now worth $70, not $28, so the value of that $800 dividend check would have become $1,995. The recessionary prices are a friend of the wonderful business, because you get to gobble up more shares at a discount that will eventually experience a coiled spring effect like when those Colgate dividend shares go from $800 to $1,995.

And that data I included understates the case of additional shares because those 28.5 shares got to pay dividends in 2009, 2010, 2011, 2012, 2013, 2014, and 2015, creating additional shares that would pay dividends themselves. The compounding engine would have still been intact if you paid $50 to reinvest in 2008, but you would have had fewer shares to produce future dividend offspring. I am using Colgate as an example here, but Chevron is really the king of this phenomenon because the oil giant’s dividend payout remains stable and the oil sector experiences regular deep swings in prices, so the regularity of the discounts and the higher relative size of the Chevron dividend payment gives you better long-term returns than the earnings per share growth of the company would suggest.

When someone talks about market timing, they act like they are predicting future business results. But really, what they are trying to do is accurately predict the irrationality of others. If a business can grow its profits and raise its dividend for 50+ years and still experience a 34% drop in stock price, that means we have entered the territory of trying to predict things that have no foundation. The reason why I find my hold-through-the-recessions approach superior is because the best companies will keep paying their dividends even while the price of the stock is lower, and that is the kind of thing that results in goosing your long-term returns at a rate above which the business is growing.

If you are acquiring ownership in businesses with growing profits that return more and more of those profits to you as cash each year, it seems foolish to plan on selling your business ownership position simply because you encounter people willing to pay a lower price for your business at a given time. It’s not something people think about during six straight years of gains, but another 20-35% stock market decline will eventually arrive, and it is important to develop your plan of response ahead of time rather than during the crisis. The plan of attack that I advocate consists of finding excellent businesses and not overpaying for your stake.