By
Chuck Carnevale
:
There is no shortage of pundits and prognosticators willing to
offer their opinions (rarely based on facts) as to whether or not
stocks are cheap or expensive, or as to whether the markets are
going to rise or fall. In every case, the opinions and
prognostications are directed as generalities such as "stocks" or
"markets." In this context, the implication is that all stocks are
the same, and therefore will all behave in the same manner or in
tandem.
In contrast, it has long been our contention that it is a market
of stocks and not a stock market. Moreover, we have also long
argued in favor of making investing decisions one stock at a time
instead of based on views about the general market. In our opinion,
general statements about the value of markets or stocks as a class
are prejudiced, and therefore, we would argue, illogical. Making
brash and general statements about stocks is analogous to thinking
like a racist. The bottom line? It is just plain wrong
thinking.
In truth, individual stocks are as unique and as different as
individual human beings. Therefore, just like human beings,
individual stocks should be measured and judged based on their own
distinctive merit. Consequently, this article is offered to cast a
bright light of insight reflecting the truth about investing in
individual stocks based on their unique characteristics instead of
prejudicial views attempting to paint them all with the same broad
brush. Generalizing doesn't work when evaluating people or common
stocks.
The Dow Jones Industrial Average - A Diverse Group of 30
Companies
When people make the general statement that the market is up or
down, or that stocks are up or down, they are typically referring
to either the S&P 500, or even more commonly the Dow Jones
Industrial Average (DJIA). The following CNBC headline is a case in
point:
"Stocks spiked Thursday, with the Dow jumping 100 points, after
the Federal Reserve pulled the trigger on launching a new round of
quantitative easing."
Therefore, this article will look at 30 stocks in the Dow Jones
Industrial Average index, commonly referred to as the "Dow."
Nevertheless, we will demonstrate that even such a small universe
of stocks contains examples of companies with very diverse
characteristics and histories. Thereby establishing our thesis that
it is more relevant to think of a market of stocks than it is a
stock market. Like most things, the devil is in the details.
The following tables list the 30 DJIA stocks in alphabetical
order and provides a simple snapshot of how diverse each of these
individual companies are. The first column shows their historical
earnings growth rates, followed by their dividend yields, their
debt (note that we do not report debt on financials) and finally
their respective sector. These simple metrics alone provide a
statistical illustration of how truly different each of these
individual "stocks" really are.
(click to enlarge)
(click to enlarge)
(click to enlarge)
Six Specific Examples Representing 20% of the
DOW
In addition to the erroneous overgeneralization of the asset
class "stocks," there is another bias that we feel both misleads
investors and even keeps them in the dark regarding the pros and
cons of investing in equities. Here, I'm referring to the fixation
on price movement and/or volatility while simultaneously
disregarding the fundamentals of the business underpinning the
stock. However, we contend that in the long run, business results
are far more important to investors than short-term price
volatility is.
Consequently, we are going to utilize
F.A.S.T.
Graphs™
(Fundamentals Analyzer Software Tool) to review 6 of the 30 Dow
components - with a twist. We're only going to look at them based
on earnings and dividends alone. In other words, we are going to
exclude stock prices altogether. Our objective is to refocus
investors away from the fixation on price and reorient it towards
the business behind the stock.
When each company (stock) is looked at from this perspective,
the differences between one business and the next are vividly
revealed. Due to the inherent volatility of stock prices in an
auction market, the common stock price charts of most companies
tend to be difficult to differentiate. In other words, from looking
at price alone, it is hard to impossible to tell much about the
business at all. This is where F.A.S.T. Graphs™ distinguish
themselves from other graphic programs. Instead of the primary
focus being on price, the primary focus is on the business first -
the price is secondary.
Therefore, as you review each of the six sample Dow components
below, we suggest that you focus on how different each company's
business results have been (the orange earnings line) and note from
the performance tables the impact that these business results have
had on long-term performance. We believe that these graphics will
make a couple of things quite clear. First, we will be given an
instant perspective of just how successful the business has been,
and second, the performance results will be vividly reflective of
each company's operating history.
Alcoa, Inc (
AA
)
Our first example, Alcoa, shows a very cyclical company with no
earnings growth (NMF stands for no meaningful figure). Clearly, we
can instantly determine that Alcoa has a very unreliable record of
earnings growth.
(click to enlarge)
When we examine the performance associated with the above
earnings (the orange line) and dividends (the blue shaded area) we
should not be surprised to discover a few very important facts.
First of all, since 1998, long-term shareholder owners of Alcoa
would have lost almost half of their principal. Second, we discover
a very unreliable dividend history that includes two large cuts in
2009 and 2010.
(click to enlarge)
Johnson & Johnson (
JNJ
)
Our second example looks at the blue-chip Johnson & Johnson,
where we discover a sharp contrast from Alcoa. With this example we
see a very steady record of earnings and dividend growth since
1998. However, it should be pointed out that since the great
recession Johnson & Johnson's earnings growth has slowed.
Nevertheless, we also see that the dividend has steadily increased
with its earnings.
(click to enlarge)
Johnson & Johnson's better earnings record has produced a
steadily rising dividend and a return beating the S&P 500.
Clearly, there is very little similarity between the stock Johnson
& Johnson and the stock called Alcoa.
(click to enlarge)
DuPont (
DD
)
Our third example, DuPont, shows a company with entirely
different characteristics than our first two. With this company, we
see not only a high-level of cyclicality, but also very little
long-term earnings growth. However, the real point is that DuPont
is a very different company than either Alcoa or Johnson &
Johnson.
(click to enlarge)
When we review the track record associated with DuPont's
business results, it's not surprising that dividend growth has been
very slow or that long-term capital appreciation has been slightly
negative. In other words, inconsistent business results generated
inconsistent and rather anemic income and growth as well.
(click to enlarge)
IBM, Inc (
IBM
)
Our fourth example looks at technology stalwart IBM. Here, we
see an example of strong earnings growth since 1998. Once again,
the point being that there is very little comparison between the
business IBM versus the business DuPont. Although both are
considered dominant blue chips, IBM is the clear business
winner.
(click to enlarge)
When a company produces the business results that IBM has, it
should be of no surprise that its long-term stock performance will
follow suit. IBM offers its shareholders a very strong record of
dividend growth and capital appreciation that has clearly
outperformed the S&P 500 by a wide margin.
(click to enlarge)
Bank of America (
BAC
)
Our fifth example reviews the business results of Bank of
America, one of the dreaded mega-financials. Clearly, Bank of
America's earnings collapsed as a result of the financial crisis,
and we might add so did their stock price (although we are not
showing it here). The point with showing this high profile company
just after we showed IBM is to illustrate the sharp contrast
between the business results of these two behemoths.
IBM went through the great recession like it never happened,
while Bank of America was decimated. Clearly, these two examples
vividly illustrate our thesis that it is a market of stocks and not
a stock market. This is another way of saying that the stock market
had little or nothing to do with the independent results of these
two companies. Instead, what mattered most was how each company
itself performed as an independent business.
(click to enlarge)
It should be no surprise to the reader that Bank of America was
a terrible long-term investment because of its horrific earnings
record. Moreover, it should also not be a surprise that the
company's dividend was slashed to almost nothing due to the
collapse of its earnings.
(click to enlarge)
Wal-Mart Stores Inc (WMT)
Our sixth and final example reviews Wal-Mart, the world's
largest and arguably greatest retailer. Wal-Mart's earnings record
over this timeframe since 1998 is impeccable and not only
distinguishes it amongst its peers, but also amongst most
companies. Although there was some short-term volatility along the
way, earnings, dividends, and ultimately price, all advanced
strongly during, through, and after the great recession of
2008.
(click to enlarge)
Great operating results translate into great shareholder
performance. This is notwithstanding the fact that Wal-Mart was
moderately overvalued at the beginning of 1998 and became very
overvalued by the end of 1999, from where stock price went sideways
before once again aligning itself with earnings by the summer of
2007. The price has advanced alongside earnings ever since.
However, regardless of the somewhat irrational nature of its
stock price, strong operating results generated an above-average
and consistent record of dividend growth in spite of its price
action. In the long run, Wal-Mart was a great business that
produced great shareholder returns. But most importantly, Wal-Mart
was a great business during a time when other businesses like
Alcoa, DuPont and Bank of America suffered severe operating
challenges.
(click to enlarge)
Don't Be The Equivalent Of A Stock Market Racist
We are quite often agitated and troubled by the amount of
negative sentiment that is placed on stocks. Most of this sentiment
is founded on generalities regarding stocks and stock markets.
Therefore, our goal in offering this piece is to try and motivate
investors to be more discerning regarding investing in equities.
Fortunately, we are not alone in our view as it is shared by many
of the world's greatest investors.
Consequently, we will close this article by sharing some famous
quotes on this important subject from several of the greatest
investors who ever lived. These investing greats have all tried to
share their wisdom regarding the undeniable fact that portfolios
should be built one company at a time, and again that it is a
market of stocks and not a stock market that we should be
concerning ourselves with.
Peter Lynch
Our first series of quotes is from Peter Lynch and his
best-selling book 'One Up On Wall Street'. Peter makes it quite
clear that not only does he not believe in predicting markets but
that he also strongly believes in making decisions one company or
business at a time.
"I don't believe in predicting markets. I believe in buying
great businesses - especially companies that are undervalued,
and/or under-appreciated"
"The stock market ought to be irrelevant. If I could
convince you of this one thing, I'd feel this book has done
it's job. And if you don't believe me, believe Warren Buffett.
"As far as I'm concerned," Buffett has written, "the stock
market doesn't exist. It is only there as a reference to see if
anybody is offering to do anything foolish."
Warren Buffett
Legendary investor Warren Buffett also shares a strong
conviction against trying to predict markets or even worrying or
fussing too much about macroeconomic concerns. We believe that most
of what Warren preaches is common sense and that his behavior can
be emulated by the general investor if they would only truly listen
to his sage advice.
"If we see anything that relates to what's going to happen
in Congress, we don't even read it. We just don't think it's
helpful to have a view on these matters."
"I never attempt to make money on the stock market. I buy
on the assumption that they could close the market the next day
and not reopen it for five years."
"(Partner) Charlie (Munger) and I never have an opinion on
the market because it wouldn't be any good and it might
interfere with the opinions we have that are good."
"If we find a company we like, the level of the market will
not really impact our decisions. We will decide company by
company. We spend essentially no time thinking about
macroeconomic factors. In other words, if somebody handed us a
prediction by the most revered intellectual on the subject,
with figures for unemployment or interest rates, or whatever it
might be for the next two years, we would not pay any attention
to it. We simply try to focus on businesses that we think we
understand and where we like the price and management."
Marty Whitman
With our next quote, we share the opinion of the renowned
manager of the successful Third Avenue Value Fund, Marty Whitman,
as he explains how much easier it is to forecast a business and its
future potential over attempting to forecast stock market behavior.
We believe this is a very profound and important piece of wisdom.
Why worry about things that you cannot analyze when things that you
can are easily available to you?
"I remain impressed with how much easier it is for us, and
everybody else who has a modicum of training, to determine what
a business is worth, and what the dynamics of the business
might be, compared with estimating the prices at which a
non-arbitrage security will sell in near-term markets."
Summary and Conclusions
We believe that one of the major forces that distracts otherwise
rational people from investing in equities is the emotional
response of fear against losses. The great recession of 2008 has
caused many people to eschew equities in favor of fixed income at
what we believe was precisely the wrong time to behave this way.
The real problem is that fear causes people to sell at the bottom,
when they should instead be taking advantage of the opportunities
presenting themselves.
The legendary investor and teacher of most of the modern
investor greats, Ben Graham, tried very hard to teach us that a
temporary decline in stock prices is an unrealized loss that will
generally correct itself if you trust that it will. Moreover, this
has always happened after every recession and bear market including
our last great one in 2008. However, in order to have the trust,
you have to have the wisdom that it requires. First, here is what
Ben had to say:
"Every investor should be prepared financially and
psychologically for the possibility of poor short-term results.
For example, in the 1973-74 decline, the investor would have
lost money on paper, but if he held on and stuck with the
approach, he would have recouped in 1975-76 and gotten an
average 15% return for the five year period."
The following graphic, courtesy of Economic Online Tutor,
provides a history of all of our recessions since the depression of
1929. There are two key points that we believe should be focused on
here. First, notice how rare it is for recessions to occur. In
fact, over more recent history, recessions have only come around
every 6-10 years or so. But second, and most importantly, notice
that they don't really last very long. In other words, better times
are much more common and last longer than bad times.
(click to enlarge)
The primary point that we have been postulating in this article
is that common stocks are very different and come in all
assortments, sizes, shapes and flavors. Consequently, we encourage
investors to think more specifically and rely more on the precise
characteristics of the individual company or companies they are
contemplating. Worrying about the general state of the economy or
the stock market, or their future direction, is not only an
exercise in futility, but an unnecessary exercise as well.
Finally, we encourage investors to know the companies in their
portfolios, focus more on their businesses and prospects, and worry
less about short-term market volatility. In other words, trust the
value of the companies you own so you can recognize valuation
anomalies as they occur, and therefore, act appropriately. If value
is low add, and if value is too high, sell - but never the other
way around.
Disclaimer:
The opinions in this document are for informational and
educational purposes only and should not be construed as a
recommendation to buy or sell the stocks mentioned or to solicit
transactions or clients. Past performance of the companies
discussed may not continue and the companies may not achieve the
earnings growth as predicted. The information in this document is
believed to be accurate, but under no circumstances should a
person act upon the information contained within. We do not
recommend that anyone act upon any investment information without
first consulting an investment advisor as to the suitability of
such investments for his specific situation.
Disclosure:
I am long [[CSCO]], [[CVX]], [[HD]], [[HPQ]], [[INTC]], [[JNJ]],
[[KFT]], [[KO]], [[MCD]]. I wrote this article myself, and it
expresses my own opinions. I am not receiving compensation for it.
I have no business relationship with any company whose stock is
mentioned in this article.
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