The Rational Investor #040: Ignore Stock Prices; Focus on the Businesses
Happy Saturday to you,
Welcome to the 40th edition of The Rational Investor Newsletter.
Today’s quote comes from Robert Hagstrom’s book The Warren Buffett Way. While this book discusses how Buffett (supposedly) selects individual securities, much of its wisdom can be just as easily applied to the broader investing landscape. One such example is the idea of ignoring stock prices and focusing on the fundamentals of the business—earnings, cash flow, dividends, etc.
I’ll share my application of this idea for the broader market in my comments that follow.
Onto the main event…
Here’s Hagstrom/Buffett on Ignoring Stock Prices and Focusing on the Fundamentals:
“Warren Buffet once said he ‘wouldn’t care if the stock market closed for a year or two. After all, it closes on Saturday and Sunday and that hasn’t bothered me yet.’ It is true that ‘an actively trading market is useful, since it periodically presents us with mouthwatering opportunities.’ said Buffett. ‘But by no means is it essential.’
To fully appreciate this statement, you need to think carefully about what Buffett said next. ‘A prolonged suspension of trading in securities we hold would not bother us any more than does the lack of daily quotations for [Berkshire’s wholly owned subsidiaries]. Eventually our economic fate will be determined by the economic fate of the business we own, whether our ownership is partial [in the form of shares of stock] or total.’
If you owned a business and there were no daily quotes to measure its performance, how would you determine your progress? Likely you would measure the growth in earnings, the increase in return on capital, or the improvement in operating margins. You simply would let the economics of the business dictate whether you were increasing or decreasing the value of your investment. In Buffett’s mind, the litmus test for measuring the performance of a publicly traded company is no different. ‘Charlie and I let our marketable equities tell us by their operating results—not by their daily, or even yearly, price quotations—whether our investments are successful,’ he explains. ‘The market may ignore a business success for a while, but it eventually will confirm it.’
Clearly, Buffett was referencing the fundamentals of individual companies, but we can do this just as easily at the market level. For instance, if you look at earnings and dividends over the course of history, it’s clear that they are far more stable than are stock prices—despite stock prices commanding nearly 100% of the media’s attention.
Earnings and dividends have reliably and sustainably grown nearly every year (check out this data from NYU to see this fact plain as day)—not to mention that they rarely fall with such viciousness as stock prices often do. I made a visual highlighting the incredible consistent growth of dividends:
Remarkably, there have only been seven years since 1960 in which dividends decreased, and only one of those was a notable decrease. Earnings have performed similarly.
Long story short, I’d argue that focusing solely on the fundamentals, such as earnings and dividends, will lead to much greater investing success than paying attention to prices ever could.
Thanks for reading. I’ll be back again next week with more timeless wisdom from great investors.
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