Sometime shortly after American Express lost its Costco exclusivity, I mentioned that American Express had gotten cheap. It was making $5.70 in profits and trading in the $70s, and things tend to work out when you buy a company with brand recognition in an oligopolistic industry that pounds out strong profits year after year. The management team mentioned that earnings would take a year or two to recover from the Costco loss as earnings growth at the rest of the firm needed to catch up and get in shape for its new call of heavy lifting, and then management expected earnings per share growth in the 12% to 15% range thereafter.
Those expectations may be a bit on the lofty side, but probably fall within the ballpark of reasonable expectations. Somewhere in my reader mailbox, I got the question: “If American Express isn’t expected to grow profits for a year or two, why not wait until then to buy the stock? What’s the point of holding something if you know you are going to tread water?” I never got around to answering that question, but I thought about it again today when I saw Friday’s price action on the stock.
One of the reasons why the stock market can make a madman of otherwise sane and logical individuals is that people can get caught up predicting when something will happen rather than what will happen. I spend my days focusing on the “what” question, figuring that if I get that question wrong I’ll be doomed for mediocrity, whereas the “when” question is unpredictable as far as I can tell and only results in a delay of compounding if you get the “what” question right.
There is also a general tendency for the market to be forward looking–the stock market started delivering strong declines in 2008 before the economic recession fully hit the American people, and the 2009 stock market price recovery generally started before the actual economy began to show commensurate improvements.
Today, investors learned that ValueAct Capital has taken a $1 billion stake in the company, and this has sent the price from $74 to over $80 as of Friday afternoon before settling at $79.72 at the end of the day. That’s a 6.3% gain in one day. If American Express does deliver on its expected earnings per share growth projections, the day August 7th, 2015 will have provided about half of the entire year’s expected stock market advance for the stock.
This is why I don’t get into most forms of market timing. I’m capable of figuring out that American Express is generally cheap, and that profits of $5.70 in 2015 will be quite higher in 2020-2025. You can make a lot of money just from that insight alone. But figuring out the when is much more difficult. I have no idea what I could study that would tell me American Express would generate half of its expected yearly gains on August 7th, 2015. That is why I have a genteel attitude about things like Chevron going from $130 to $85–if you get the “what” right, you will eventually be vindicated even if the interim is bumpy and filled with the overreactions of my peers that make up the personal finance commentariat.
One of my favorite law school professors once told me that the best students, and subsequently best lawyers, don’t go through life providing the best answers but rather go through it asking the best questions. Why would a wise man say this? Because if you get the questions right, it means you know the right thing to value, and the rest is up to your research skills.
It seems to me that people worried about price movements of the stock market are always going through life focused on other people’s estimates of value. After all, that is what a stock price is–the price someone else recently though it was worth to pay for an ownership slice. Instead, the best investors are always asking about long-term competitive advantages, earnings expectations, sustainable profit margins, and the general calculations of long-term reinvested dividends. It seems a more sane way to behave because it is more predictable and requires far, far less work once you make the initial investment decision.