Q3 finally saw stocks take a little rest. The S&P 500 just about scratched out positive returns, with the NASDAQ doing the exact opposite. Inflation has been a big topic in recent months. Transitory? Or embedded? What effect will that have on equity valuations? Furthermore, what about the tens of billions of dollars in monthly bond purchases by the Fed? The latest news suggests that may end a bit sooner than expected. Will that negatively impact demand for financial assets? In which case the speculative end of the market may really be in for a rough ride.
While it’s hard to say anything for certain, here’s what I think is pretty clear cut: multiples have expanded significantly these past several years. Riding a wave of multiple expansion feels great because total returns outperform the combination of earnings and dividend growth. Conversely, holding through a period of contracting valuations feels horrible because total returns underperform the same combination. Indeed, investors who have dabbled in certain overseas markets may have experienced that in recent times. These trends can go on for many years, and sometimes have no other cause other than what the money is chasing.
Something else that is always worth bearing in mind is this: the more expensive a stock gets, the more correct one has to be with respect to extrapolating growth and so on. Ditto for earnings quality. This is often very tricky to do in practice, and if that seems blindingly obvious then consider the opposite scenario. That is to say, a cheap stock which can afford you more leeway. A good example of this is Microsoft ten years ago. Microsoft averaged a PE ratio of around 10 across 2011 and 2012. At its lowest points the stock traded on a single-digit earnings multiple.
In hindsight, it looks like one of the easiest slam dunks of all time, but that is in large part due to the company’s tremendous recent earnings growth. Ten years ago, Microsoft stock probably only attracted the value investing crowd, and I wonder how many investors back then would have correctly guessed the subsequent 10-year earnings growth rate.
As for the portfolios here, the Micro Portfolio is basically a slow moving example of Charlie Munger’s famous line about the first $100k being the hardest. The value of those stocks stood at around $1,760 at the end of Q3, of which $160 represents capital gains. They have also produced a little over $25 in total dividend cash. The Micro Portfolio‘s share of its holdings’ annual earnings stood at just under $85 in Q3. This is something that I think is helpful for investors to track in addition to the headline portfolio value. Dividend investors can, and often do, similarly track projected dividend income.
Fortunes continue to be a bit mixed in the Coffee Can Portfolio, where value is very much the theme. Exxon Mobil has done very well. The cost basis there is in the low-$40s per share, which represents a dividend yield on cost of around 8%! Elsewhere, AT&T remains a poor performer, but it is very cheap right now. Likewise for Anheuser-Busch InBev, which is bogged down by emerging market exposure among other issues. On the plus side, the portfolio continues to pump out plenty of dividend cash. The Coffee Can Portfolio’s holdings were worth $10,448.45 at the end of Q3, with their share of 2021 estimated earnings at over $850. Cumulative dividends received at period end since period end stood at just over $460.
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