Earnings Are When They Tell You How Much Money You Made

You bought a duplex. Every month, every year, you tote up your expenses; mortgage, maintenance, taxes, fees … and you subtract that from how much you received in rent. The difference is what your investment actually nets you.

Or suppose you opened up a restaurant, or started a manufacturing company. Your measure of your return on your investment works much the same way; you subtract how much you paid for ingredients, what you paid in wages, utilities, etcetera, and what’s left over is the return you receive on your investment.

But for some reason, when you invest in stocks, you’re supposed to forget about all that. It’s hard not to … every day, the financial media tell you how much they “went up” or went down. They will report how much bonds yield, but how much the S&P or Dow or Nasdaq yields is something that, if you want to know, you’re gonna have to dig for it.

Imagine if you ran your duplex, restaurant, or factory that way. Today it “went up” 1.2%. The next it’s “down” 0.7%. Why not? There is no ticker, no chart, to tell you how much could could sell it for, second by second, minute by minute. You will find no headlines reminding you day by day, week by week, what your business is worth.

But is investing in stocks fundamentally different than owning a business? The world’s great investors say that’s how you should look at it. When you buy a stock, you become part owner of the company that issues it. As such, the cash flow that you receive is what you should care about most.

But wait … don’t you care about what you might eventually sell your apartment, restaurant or factory for? Sure, but how do you know what that will be? You don’t … you can only speculate. Aside from that, if you manage your business well and grow the profits you receive on it over the years, that will pretty much take care of itself. If you don’t, you may not own it long enough to find out.

What I’m driving at is that when you invest in stocks, you’re immersed in a world that encourages you to think about it in a highly artificial way. You’re constantly bombarded with information about what you could sell your investment for. Even though you may have no intention of selling it for years, you’re constantly being told that what you could sell it for is what you should be focusing on.

The cynic in me whispers that it’s not just a matter of technology and tick-by-tick public auction markets that this happens. The issuers of stock  – the stocks that you hear about most – would just as soon you didn’t think too much about the cash flow you receive on your investment. They would rather send you a statement of how much much money they made on your behalf than send you the actual money. It’s just a lot easier.

They have persuasive excuses. It’s better for us to “reinvest” our profits in growing the business. That way, our stock price will go up. They don’t tell you though that if they don’t send you money along the way, the only way you’ll be able to get the benefit of their investing genius is for you to sell.

And the yield on today’s S&P is pathetic … not something they would want to advertise. The higher the price, the lower the yield.

Another matter is the issue of predictability. What you might be able to sell your business for in ten or twenty years is highly speculative. It depends heavily on things you can’t know. It’s not fundamentally different with stocks. A buyer of American stocks in 1929 was nearly certain of being able to sell them years later at astronomical prices. The same for a buyer of Japanese stocks in 1989. Both were badly mistaken. It took over two decades for American stocks to just recover their 1929 levels, and it wasn’t until this year that Japanese stocks recovered their 1989 levels. Dividends can fluctuate too, but in comparison with prices they’re more predictable. They depend less on transient factors like cycles of monetary policy and investor sentiment, and more on business fundamentals. Not to mention you begin to realize a tangible return within months, so you can’t lose your entire investment. 

There’s a bigger fly in the ointment yet. While it may be true that reinvesting earnings may help grow the business at an individual company, the truth is a little murkier on a market-wide basis. As a whole, the total market share is 100%. So in the aggregate, all this earnings reinvestment can only be maintaining market share. It cannot grow it. So most of whatever earnings are retained by public corporations to grow market share as a lot is actually being used to merely maintain market share. In other words, they’re not true profits … they are expenses the business must bear just to maintain the status quo.

The so-called “equity premium”, then, based on earnings, is misleading. An apples-to-apples comparison with bonds would be based on dividends. With an S&P dividend yield of about 1.35%, stocks would need to sell about half their current prices to just to yield 2.70%, which after accounting for dividend growth, might be competitive with bonds yielding 4%-5%.

To the extent profits are genuine and sustainable, they can be paid in dividends. Sending you money and keeping it up means the profits have to be real. And that you, not merely corporate insiders, are benefitting from them.

Since the turn of the century in fact, in the aggregate, investors have not made money on stocks. They’ve been a good inflation hedge, but in real terms, investors have actually subsidized corporate operations … or at least corporate insiders and Wall Street. Inflation – depreciation of the unit of account – accounts for the apparent big gains in stocks, but as measured in terms of gold, investors have lost value in stocks. And it’s not just gold; the same is true in terms of copper. That’s right, stocks of our dynamic corporations have lost ground to mere chunks of inert metal. And based on the above yield data, that seems likely to continue.

Earnings are when they tell you how much money you made.

Dividends are when they send it to you.



Leave a Reply

Your email address will not be published. Required fields are marked *