Valuation Still Matters
...this beat goes on, and on and on
by Jeff Fischer ([email protected])
ALEXANDRIA, VA (Sept. 24, 1998) --Stocks that led the recent market descent also led the recent resurgence. As of yesterday, the small stocks constituting the Nasdaq 100 had gained 22% for the month and the Nasdaq Composite was up 17%. In comparison, the S&P 500 had gained only 11% this month, and the giant Dow had recouped a comparably slight 8%. The Drip Port, though holding only large companies, was ahead 14% for September as of yesterday. Today everything declined over 2%.
It's interesting to note that we've done better by investing in Intel and Johnson & Johnson over the past 10 and 8 months, respectively, than we would have done investing in Coca-Cola and Pfizer, because those stocks rose early in the year and were higher for much of it, but are now down from earlier prices at which we would have bought. Instead, Intel has been all over the board (providing opportunities), but is up 19% for 1998 due to a recent gain, and Johnson & Johnson has been one of the steadiest Dow stocks this year -- slowing rising. Slowing rising to a 20% gain, that is.
The total return is what matters, though, and for us the total return while dollar-cost-averaging (a return which can be substantially different from a lump-sum return) is what truly matters. We hope to beat the market by investing each dollar at reasonable valuations, at least as much as possible.
A stock's initial valuation and its subsequent rate of return go hand-in-hand, with the business performance setting the eventual pace. ("Eventual" pace because an overvalued stock can sit and spin for years no matter what the business is doing.) We began to invest in our stocks at reasonable valuations, we felt, and for this reason.
It's fallacious to buy the argument that if you're dollar-cost-averaging valuation doesn't matter. You don't have an endless amount of dollars to invest, so the price at which you invest each dollar does indeed matter. The price that you pay per share will always determine your eventual return. You can't separate the two. No matter how well the business eventually outperforms and how much higher the stock goes, the investor with the lower cost-basis will outperform (and often heartily) anyone who paid more. Granted, though, when dollar-cost-averaging and beginning with small amounts of money, the valuation that you pay at the very beginning is less important.
Or is it?
Actually, the valuation that you pay at the beginning, even with small amounts, might be the most important. The money that you first invest has the longest amount of time to compound -- or not compound, as the case may be. Perhaps the first dollar that you invest is the most important of all, because time is an ultimate producer of wealth if used correctly.
It's easy to think lightly of high valuations following a record 15-year stock market, but equities can just as easily linger for many years, and during those years only stocks that had reasonable valuations to begin with offer much hope for decent returns. It's said that the stock market is not very efficient in the short-term (it gets caught in its own whims and fancies, sometimes for years), but in the long-term, it's incredibly efficient. A business is a business, and cash flow is cash flow. Valuing it isn't an amazingly mysterious ordeal over the long run.
Most mature companies will, over time, grow within a predictable range, and the cash that they throw off is more or less valuable depending on interest rates, inflation, and the rate of return that a company can achieve by investing income back into its business. "Emotion" or market psychology is only a temporary valuation enhancer (or detractor).
Investing in the best companies increases your chance for a better return even if you pay a high price. True. But if you're sensitive to valuation (not overly sensitive, but reasonably) you should be that much better situated over time.
Money Sent. After fourteen months that included coverage of four industries and over fifty companies, we hold two active investments. We had three at one point, but alas... our Campbell Soup position is at least temporarily inactive. However, we'll soon add another child to our playpen of two.
The money to invest in Mellon Bank (NYSE: MEL) was mailed on Monday. In order to enroll in Mellon's dividend reinvestment plan using Moneypaper's service, they need to receive your order by October 15. Otherwise you'll need to wait another three months (it's a quarterly offering) if you're interested in buying it (at all) and through Moneypaper.
We haven't sent our $100 investment for early October yet. We'll figure that out tomorrow.
Thank you to Vince Hanks for three great columns over the last three days. We'll see Vince here again soon, and our Drip community sees him each day on the message boards that are linked in the top right of this page. He's incredibly helpful out there. Thanks, Vince. Fool on everyone!
--Jeff Fischer
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