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Thinking Like a Business Owner

| November 20, 2018
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Thinking Like a Business Owner

US stocks continue their slump.  Tech stocks which had run up sharply earlier in the year are giving back nearly all of this years gains and more as investors come to doubt the sales and profit assumptions on which those lofty prices were based.  The S&P 500 is down a little over 10% from its peak – back in correction territory again.  The large tech stocks (Amazon, Facebook, Apple, Netflix, Google, etc.) which had been drivers of growth for the first ¾ of the year are taking the biggest hit.  All 5 are down over 20% from their highs. 

But still, few voices are calling for the economy to fall off a cliff.  Few forecasters are calling for a recession.  But many suspect that growth may be a little slower than previously estimated, while uncertainties surrounding trade policy and global economic conditions weigh on investors minds. Higher interest rates have started to bite as well – as investors now have decent yielding alternatives to stocks, while higher mortgage and loan rates start to have an impact on demand. 

Patience can be challenging when headlines scream of falling prices – but as I’ve noted in previous correspondence – this is normal market behavior.  Stocks find their correct price in the way a bouncing ball comes to rest.  Bounce to high, fall back, rebound, fall back, etc.  

As long term investors, we all should look past daily market movements and remember we are invested in the most powerful profit making engine of all time – the US (and global) economy.  If you own an index fund, you are a part owner of every publicly traded company in the country.  Stock prices of those firms may bounce around on a daily and monthly basis as traders try to forecast the exact amount of future earnings.  And that forecast can change on an hourly basis based on news flow.  But in the long run, today’s stock price will be completely irrelevant 5 years from now.  Corporations will continue to earn money, regardless of what the market thinks, and we continue to share in and benefit from those profits. 

In fact, a good stock investor thinks more like a real estate investor or small business owner than a trader.  The price of an investment property may go up or down based on local conditions or the overall economy, but as long as the investor is earning rent and making money, the price of the property is not of much concern, until he is ready to sell.  

It helps during periods of market turmoil to recall that as a stock investor – you are earning profits. The dollars may not be as visible as the rent payed to the building owner, but they are no less real.  Those profits companies earn may benefit you directly and visibly as cash dividend payouts – but even the profits that are not paid out in cash ultimately benefit you.  How so?  Well there are several things a company can do with the cash they earn, and all are to your long term benefit. 

  1. Firms can pay dividends. You can reinvest those dividends to buy more shares (fueling compound growth) or take the money as income in retirement.  Dividends are easy to see because they appear right on your monthly statement. 
  2. Firms can invest their profits to make more money. A growing company will reinvest  profits to build capacity, to earn more profits in the future.  Over the long run, that will support a higher stock price.
  3. Firms can leave the earnings in cash. That increases the book value of the business – and that cash will eventually fund future dividends and investments.
  4. Firms can buy back stock. In recent years, firms frequently use their cash to buy back their own stock, which tends to push up the stock price by reducing supply. 

Just as the real estate investor is likely to ignore price movements and rest assured that his profit making investment will work out over time, stock investors should do the same.  Let the profit machine of the global economy do its work, give it time to do its job, and stop worrying about what others will pay for it today. 

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