Published March 12th, 2015
Investing in the stock market can feel a lot like playing the lottery. The daily, monthly, and even yearly fluctuations in stock prices seem completely random. In the short run, price performance is dictated by perception rather than underlying business strength. Shifts in perception (either warranted or unwarranted) cause stock prices to advance and decline. Over the course of multiple years, price performance is determined not by perception, but by underlying business growth. If a business grows 10% a year every year, it’s long-term performance will eventually match business growth.
“In the short run, the market is a voting machine but in the long run, it is a weighing machine”
– Benjamin Graham
How would your investing process change if you focused on the long run underlying business performance rather than short run price changes?
Stock Price Versus Stock Dividend
I believe that the short run focus in the market is a result of investors paying attention to the wrong metrics. Instead of worrying if a company will miss analyst expectations by a few pennies (does this really even matter?), why don’t we focus on how a business is expected to grow over the next 5 or 10 years?
Looking at daily or monthly price changes is a poor way to gauge business growth. Turning your attention to dividend payments, however, is a much better idea. Out of the 155 businesses in the Sure Dividend database, Johnson & Johnson (JNJ) has the lowest stock price standard deviation at just over 16% a year. Even an ultra-low volatility stock goes through stressful stock price plunges and dizzying gains, as the picture below shows:
Instead of focusing on the roller-coaster of stock price, look at how consistent the company’s dividend payments have risen. If an investor checked dividend payments instead of the company’s stock price, they would have had no stress about the future of their investment. Now take a look at a stock with high price volatility; AFLAC (AFL):
If the Johnson & Johnson example didn’t drive home the point that dividends fluctuate much less than stock price, the AFLAC picture above certainly will. Few investors can stomach a stock price decline from over $65 to under $15 (ouch!). If one looked at the dividend alone, they only would have seen business growth.
Looking at dividend payments instead of price movement is not putting blinders on. It is focusing on what really matters. Dividend growth reflects underlying business growth. A company simply cannot pay increasing dividends year after year without growing its business. Eventually, it would be paying out more in dividends than it has in earnings; a sure fire way to declare bankruptcy. Because of the unfeasibility of growing dividends without underlying business growth, dividend increases tend to reflect actual business growth.
Other Stable Metrics
Dividends tend to be the most stable metric to use when analyzing a stock over multiple years. Two other stable metrics are book value per share and revenue value per share. The image below shows Procter & Gamble’s (PG) growth over these metrics in the last 10 years. Notice that dividends are the most stable. Book value per share and revenue per share are less stable than dividends, but more stable than stock price from year to year.
Of course, not all stocks pay dividends. If a stock doesn’t pay a dividend, then revenue per share growth and book value per share growth are the best metrics to gauge underlying business growth. They are less prone to one-year accounting adjustments and irregularities than earnings per share. The image below shows Google’s (GOOGL) book value per share and revenue per share growth over the last 10 years. Note how stable the company’s book value per share growth has been:
If you can choose just one metric, dividends paid per share best shows underlying business growth (usually). I prefer to use the lower of dividend growth and either revenue or book value per share growth, as this better accounts for businesses that are growing their dividend payments faster than underlying business growth, as well as businesses that are being stingy and not rewarding shareholders with dividend growth equal to business growth.