Sunday, October 16, 2016

How to Stay Patient

After purchasing our house last year, I went onto the popular real estate site, Zillow, to register as the property's owner. Among other things, this allowed me to control and update the house's data on the site.

It also provided me with weekly email updates of the house's "Zestimate" - Zillow's estimated home price forecast.

Adding unnecessary emotions

The first few emails showed higher Zestimates for my home. Up $3,000, up $2,000 - "Great!" I thought, "Looks like I paid a good price for the place."

A few weeks later, I received an email telling me that the house price had gone down a few thousand dollars. "Maybe I got ripped off," I worried.

Realizing the error of my ways, I turned off the weekly emails. After all, this is the home my wife and I intend to own for the next 30-plus years. Why in the world did I care about a weekly price estimate?

The fact is that I cared for same reason that so many of us religiously check our stock prices each day. After making a major financial decision in which the asset's future value is uncertain, we seek affirmation that we didn't just make a huge mistake.

Market price vs. intrinsic value

Market prices provide us with this frequent feedback we desire. Whether or not like the feedback we receive is something different altogether and can lead us to impulsive decisions.

It's critical to remember that an analyst upgrade or downgrade, a market plunge, or an earnings "beat" or "miss" this week will have little-to-no impact on the value of our stocks 10, 20, or 30 years from now. What will matter is whether or not the company continues to build intrinsic value over time.

In other words:
  • Was the company able to defend - and ideally strengthen - its competitive advantages?
  • Did management prudently reinvest capital into high-return projects?
  • Was the company able to introduce new products and continue to delight existing customers?
  • Did management reduce costs and otherwise streamline production without sacrificing product quality?
For evidence of a company's progress to these ends, we can look for growth in value-linked metrics like dividends per share, free cash flow per share, book value per share, or "owner earnings."

Consider, for example, this chart of 3M's stock price and dividend per share from January 1970 to December 2015. At times, the market price implied a story at great odds with what the dividend growth suggested.

Source: Yahoo! Finance and author calculations
While the stock price moved erratically at times, the board continued to express long-term confidence by consistently raising the payout. Someone focused solely on the market price and without consideration of 3M's value creation would have been far less likely to stay the course.

Bottom line

The more we focus our attention on value-linked yardsticks and not on short-term market price fluctuations, the more we'll be able to maintain a patient mindset and give ourselves the best chance of realizing high rates of compounding returns.

Stay patient, stay focused.



The opinions expressed here are the author's and not those of his employer. For a full disclaimer, please click here