The more I study investing, the more I realize that one initial impression that I had about the stock market in general, and index funds in particular, turns out to be wrong: When I would look at index funds that returned 10% over a particular period, I initially assumed that most of the stocks delivered returns similar to that 10% mark—I figured most would clump together in the 8% to 12% range, and sure, you’d have a few outliers.
The more I dive into understanding stock market returns, the more I realize that there are often very focused “magic stocks” that are responsible for most of the results. For instance, when you look … Read the rest of this article!
The 1998-2000 time period should be our best friend for helping us understand the important connection between price and value. Coca-Cola stock, which has grown earnings per share by 7.2% and paid out 2.8% per share in dividends during the past twenty years, has not delivered 10% annual returns but instead has only delivered 4.8% annual returns because the P/E ratio was over 50 at the start of the period. On the other hand, Starbucks stock traded at 30x earnings in 1995 and has delivered 21.2% annual returns since then.
From a margin of safety perspective, there is a list of risk inherent in paying over 30x earnings for an investment in any … Read the rest of this article!