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.




Originally posted 2014-04-10 06:00:08.

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6 thoughts on “Michael Lewis And Flash Traders Do Not Affect Long-Term Investors

  1. scchan_2009 says:

    What I see about the true problem of HFT is it is that is throwing money on things with unclear use. It goes back to Buffett’s argument about making paintings “I can hire many people to paint portraits of me, and GDP will go up, but utility is zilt.”
    So the argument isn’t about personal investments, but you always hope the economy to be more efficient and people not doing “silly things”.

  2. innerscorecard says:

    In fact it is rather good for long-term investors in the market to see that only 50% of people in the US think that it’s a good idea to invest in stocks.

    It is sad for those who pay attention to the mainstream media, however, that their financial future is compromised based on short-term stories meant to generate buzz.

    I also think that Michael Lewis is being rather disingenuous. I think this just goes to show how principled someone like Warren Buffett is in contrast. Everything he tells people to do is actionable and responsible. A member of the general population who reads Lewis’ books, on the other hand, will be entertained, but will also be full of a vague fear of investing.

  3. Joe_G from Seeking Alpha says:

    If you tell people that high-frequency traders are front running trades by a fraction of a second and causing them to pay a tiny amount more for every trade they execute, they will shrug and say it’s not affecting them because they’re long-term investors.

    Tell those same people that you want to impose a fraction of a cent tax on stock trades to fund the public good and they will freak out and tell you that you’re endangering capitalism as we know it.

    So Tim, tell me if you can spot the difference?

  4. scchan_2009 says:

    Joe_G from Seeking Alpha I think anything with the “tax” word is going to sell to any people. People just hate that word.
    Whether “Tobin Tax” actually works for what it is intended, I think it is debatable. In some ways, I am not too worried about HFT of actual stocks. I am far more worried with the derivative markets (which may or may not include HFT; speculation is far more dangerous than trading often). It is never sound strategy to trade too often (which will incur a lot of trading fees (and Tobin Tax if they exist for that particular market) and require constant fiddling – i.e. wasting a lot of personal time and attention to get poorer return!). Econometric figures have always shown buy-and-hold for long times give superior returns over excessive trading.

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