Investing During All Time Highs - Back to Basics
As the S&P 500 reached a milestone marker of 5,000 for the first time on February 9, 2024, I believe it’s a good time to reflect on long-term investing in the stock market. Some people may wonder: is the stock market all a big gamble or like a casino? Should I buy or sell when the market hits all-time highs? Is this growth sustainable? Is there any rhyme or reason to the stock market’s performance?
There are certainly no guarantees or assurances of returns in capital markets, particularly in the short-term. However, the long-term expectation is companies grow revenue and earnings, then typically use those proceeds to (1) reinvest in the business for growth and/or (2) return capital to shareholders via dividends and/or share repurchases over time. We believe this is a repeatable process that by definition will continue to create growth opportunities so long as the process continues.
To illustrate the power of this cycle, I think it’s helpful to drill down to a single company. As to not appear to recommend any specific investment company or provide advice, I will not include the company name. What you should know is this is a real, historical example of a US based, S&P 500 company not in the tech sector. At the start of 2015, this company’s stock price was trading at record highs at that time (source: KoyFin). Investors might have been rightfully tempted at that time to cash out. After all, how long can this last? Let’s see what happened over the following ~9 years:
After trading at then all-time highs starting in 2015, the company had a total return of nearly 4x (assuming dividends reinvested, excluding any taxes or fees) in the following 9 years which is equal to a 16% compound annual growth rate. Revenue grew at 5.4% compounded annually. As a comparison, nominal US GDP growth in the same 9-year period was about 5.1% according to the St. Louis Fed economic data site (FRED). That means the company’s revenue grew about in line with the broad US economy. Over time, the company grew more efficient and increased profitability as they scaled which resulted in growing net income by about 3x.
Now let’s turn to their capital allocation. First, they repurchased nearly 40% of shares outstanding over the past 9 years. That means each remaining share receives 40% more of the profit pool than 9 years ago. As the data table above illustrates, by dividing the net income that tripled over the last 9 years by the the new reduced number of shares, the new earnings per share increases nearly 5x! In lockstep with the net income increase and share count reduction, the dividend per share also nearly increased fivefold. What might be the most interesting part of this company’s success is the price you pay for $1 of earnings declined by 35% in this time period (from 27.5x to 17.8x as shown in the table), meaning the shares trade for a cheaper price-to-earnings valuation today than 9 years ago.
To recap, a US based non-technology company:
(1) grew revenues in line with the broad US economy
(2) increased their efficiencies as they scaled and increased profitability
(3) returned capital to shareholders via dividend growth and share repurchases and
(4) as a result experienced nearly ~4x in total return.
This formula has been repeated over and over again across industries and companies, and we believe this formula is repeatable into the future. Now, let’s give this particular company credit for execution over these years. However, the company did not have a breakthrough invention or technology that 10x revenue in 2 years. They simply grew with the economy, increased profitability, and had a good return of capital plan to long-term shareholders.
For investors, the primary key was to let this formula compound over time. It has not been a straight line for this company. There were years of earnings decline, which led to stock price declines along the way. And certainly not every company has such a happy ending as this one. For any individual company, there is no assurance a company will recover from a major price decline. To help mitigate that risk, we continue to advocate for diversification. We believe owning high quality, profitable, dividend growing companies trading for what we deem are reasonable valuations diversified across industries, geographies, and company size is still a path to compound returns over the long run. That includes when the market is experiencing a drawdown, trading at record highs, or somewhere in-between.
To learn more about how Seven Springs Wealth Group approaches long-term investing (or if you just have to know the aforementioned company name), please contact us today.
Andy Michael, CFA
Portfolio Manager
