Is It Business Growth Or Trading Price Movement?
The Investment Perspective – November 2022
“Neither the investing method nor the fundamentals of the business are right or wrong because the mood of the market is favourable or unfavourable toward the “stock”. That is because when you really think about it, “stocks” (shares) are all about the financials and the trading price, the share price… the cash up value. What matters more is the economics of the business”
Peter Flannery
Key Points:
- So, is it business growth or trading price movement that matters more?
- Therefore what do you actually do then?
- See’s Candies, a real success story. Take a quick look at it.
- What’s happening with Alphabet (Google)?
To Make Money Investing – What Should They Do?
The above image represents three people who invested in the same stock at different times.
As you can see Catie invested early making 133%, Ben quite a bit later losing 38% whereas Arnold only recently invested and is happy because he made 5%. The question is “Should they treat this investment differently?”
Dull, and yet brilliant.
To help with the quiz above you may like to read some investing gold from The Oracle of Omaha. An excerpt from his 1984 letter to shareholders. Remember the ‘typewriter font’ from back in the 1980s?!
Editor’s Note:
It is about profitability – not profit.
Editor’s Note:
Company managers that increase earnings by increasing the size of the company may not be improving the business or their performance as managers. For example, if they grow the size of the business ( a rights issue, debt, acquire another business) even if profit increases, if the return on capital invested in the larger business declines, business performance just got worse. Business performance is about the return on shareholders’ funds (the capital invested in the business) – profitability. Profit is interesting, but is a simplistic and unreliable measure of both business performance and management performance.
Alphabet (Google), what’s happening?
Some large technology companies like Google reported profits last week (first week in November 2022) with some disappointments emerging.
Some companies reported slowing growth, headwinds from a strong US dollar along with rising costs (inflation).
Interestingly, the Dow Jones which represents the broader market shrugged the news off whereas the tech heavy NASDAQ declined as some of its largest companies saw their trading price decline by more than 10%.
For example, Alphabet’s revenue came in at US$57.27 billion, slightly lower than expected while year-over-year growth fell by 6%. This is the slowest rate since June 2020.
Earnings per share came in lower than expected at US$1.06 versus the US$1.25 consensus estimate. YouTube’s numbers also declined.
Alphabet could be considered an online advertising business and we can argue that spending on advertisements can be cyclical. In other words, spending on advertising can rise and fall with the business cycle.
Therefore it’s not that surprising to see revenue (turnover) growth slowing down in the current economic environment.
By the way, the third quarter last year (against which this most recent quarter is being measured) was one of the best quarters in the company’s history. Also, it’s interesting to note that revenue is up 75% since the start of the pandemic.
The real question for investors is…??
The real question is “What is the likely growth rate for the business over the next 5 to 10 years?”
Over the last 10 years revenues grew at approximately 20% per annum which is unlikely to continue over the next 5 to 10 years, given the size of the business.
Analysts’ forecast estimates suggest revenue potential growth at 11% per annum in the future.
Whilst they are only estimates, when we look at a variety of valuation methods that we would apply to Alphabet the business, this business ticks a number of boxes for us as eco-Investors.
That’s because whilst markets and cycles do matter, as for the business, and for us as investors, it really is all about the underlying economics of the business (brand strength, ecosystem strength, competitive advantage and the like).
And the answer is…
For those who play the stock market, they may make decisions based on the movement in the stock price.
For us as eco-Investors (based on value investing), the right answer is to consider how the business will perform in the future.
What else needs to be said?
“Know what you own, and why you own it.”
Peter Lynch