Time, Value and Long-Term Investment Performance

Being a great investor and managing your retirement are two different things. Ray Dalio, founder of the largest hedge fund in the world, Bridgewater Associates, said “To be a truly great investor you have to bet against the consensus and then be right.”

While Dalio’s insight is not revolutionary, there is a secret to investing. Investors can only buy what others are selling. As one person pays a certain price for a share of stock, another individual is willing to sell at virtually the same price.  What makes the buyer think he or she knows more than the seller?

At the Financial Enhancement Group, we manage approximately $320 million for families in 31 states. Data does not dictate the stocks we buy and sell. Instead, we buy and sell stocks based on each family’s needs. In sporting terms, our objective is to get on base. We do not intend to always hit a home run by selecting a stock that quickly triples in value. Our buying and selling decisions are not based entirely on opinions about a stock’s valuation. Instead, decisions are based on an investor’s current need and how an investment fits into the investor’s strategy. Valuation still matters, but it is not the only factor influencing investment decisions.

A long-term investment strategy requires sticking to a disciplined process. Investors cannot allow themselves to become distracted by shiny new offerings. Nor can investors afford to be dazzled by trends. Our in-house Chartered Financial Analyst (CFA^®) charterholder, Adam Harter, recently reviewed some interesting research on returns and future valuations.

The research from GMO, Worldscope, Compustat and MSCI, examined stock returns from 1970 through December 2016. The research then compared each stock’s performance to its performance over the past seven years. The resulting insights are important and meaningful for disciplined investors. However, the research findings are less important for people trying to score “home runs” with individual stocks.

The individual companies that make up an index change more often than most people think. More than one-third of the companies in the S&P 500 today were not part of the index in 2000. As an unmanaged index, the S&P 500 was never designed to guide investment decisions.

A stock’s past return is broken into four parts: dividends, margin, multiples paid by investors and real growth. “Dividends” are the profits returned to shareholders. “Margin” is the profitability increase resulting from inventory management, technology improvements and capacity utilization. “Multiples” represent the amount investors are willing to pay for that profit. (For instance, consider a stock’s price-to-earnings ratio moving from 13 to 18.) “Real growth” represents actual growth of the stock after backing out inflationary impacts.

Real growth for the S&P 500 between 1970 and 2016 was 6.3% annually. The dividend was the largest contributor at 3.4%. Real growth (after inflation) was 2.3%. Margin and multiple were virtually nonexistent. Over the last seven years, we have averaged growth of 13.6% with dividends being the least significant. Analysts, including Harter, question if that pace can continue.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.