One could rephrase that question:
Do you see yourself as a stock owner or a company owner?
Are you an investor or a speculator?
The reason I ask is because, behaviourally, who you are as capital allocator will probably define your expectations of how that capital is expected to perform.
My motivation in writing this is to help income investors define themselves accurately (and honestly), and by doing so manage their expectations accordingly.
Controversial as it may sound, I believe many people who call themselves ‘investors’ are in fact speculators. Most people who own stock – individual or index, have an innate expectation that it will increase in price. Why else would you buy it right? But implicit in the expectation is acceptance that all future values of your asset will be determined by other people – known collectively as ‘the Market.’ As soon as you place the determinant of value in somebody else’s hands you’ve become a speculator. Why? Because you are expecting someone or something to do something that will fulfil your expectations. You have stopped acting like the part owner of a business. Instead, you are now both participant and spectator in an event that assigns a value to that business each trading day. The process that assigns that daily value may be rational or it may be arbitrary. More likely, those buy/sell decisions that decide the stock’s price have little to do with the outlook of the business itself. The outlook for most established businesses do not change much in the short term, as Daniel Peris points out in his excellent book ‘The Strategic Dividend Investor’:
“The simple fact is that long-term distributable cash flows from large, publicly owned companies don’t vary much day to day.”
But the market’s valuation of those cash flows will.
If you are truly an income investor – read company owner, rather than a stock owner you will not care how the Stock Market price tags your body of capital each day. What you will care about – and should only care about, is the amount of income that your capital produces each year. Because that is what you would care about if you owned the whole company. And if you owned the whole company its value would not reset each day in a public auction market. Warren Buffett, who prefers to buy whole companies puts it perfectly:
“I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.”
Align yourself with this belief, it will serve you well. Remember, the value of the stock, and the value of the underlying business are not the same thing. The value of a business is its ability to produce growing income streams over time. If you, instead, place significance on the stock market’s daily reset – you are probably at heart a speculator. If an income investor is convinced the underlying business is sound, he will only be concerned with how that business is performing. Is it growing earnings? Are management passing those increases along to stockholders in the form of dividend increases? And if the business is performing, he should not care how the stock is performing. But.. (and this is as close to a guarantee you will ever get in this business),if your invested capital produces a growing income stream, that capital will naturally be worth more over time. Or as Buffett succinctly puts it, “If a business does well, the stock eventually follows.” You just don’t know when. Neither should you care. But think about the logic of this for a second. If the EPS increases over time, eventually the stock has to increase in price. Otherwise, taken to its logical conclusion the annual dividend and the stock price will eventually reach parity, and all equities trade on a forward multiple greater than 1.
If you see yourself as a Stock Market Investor you will care what the stock market does. If you see yourself as company owner you will care what the underlying business does. Essentially, as an income investor you need that company to execute on two things:
1: Grow EPS over time.
2: Commitment from management to pass on the increase in earnings to stockholders in the form of a growing dividend.
It really is that simple. It just takes, discipline and time to let it work. In the meantime don’t get distracted by the market.